Liquidity, Information Production, and Debt-Equity Choice
36 Pages Posted: 29 Jul 2019 Last revised: 6 Jan 2021
Date Written: March 1, 2020
We show that stock liquidity increases the propensity of firms to raise debt capital. The positive effect of liquidity on a debt issuance propensity is much stronger in firms with greater default risk. The effect of liquidity on the cost of debt capital is much larger than its effect on the cost of equity capital. These results are consistent with standard theoretical frameworks for financing under uncertainty and asymmetric information: by facilitating information production, stock liquidity reduces insider and market uncertainty about future firm cash flows, thereby lowering the default risk and thus the costs of debt financing.
Keywords: Stock liquidity, Debt issuance, Equity issuance, Capital structure
JEL Classification: G12, G32
Suggested Citation: Suggested Citation