The Effect of Stock Liquidity on Corporate Cash Holdings: The Real Investment Motive

Abstract

This study examines the relationship between stock liquidity and corporate cash holdings and explores a new economic mechanism driving this relationship. Using a regression discontinuity design (RDD) approach based on the annual reconstitution of the Russell 1000/2000 indices, we find that stock liquidity has a positive causal effect on corporate cash holdings. This effect is more pronounced for firms with more investment opportunities. These results suggest that enhanced stock liquidity increases corporate cash holdings by expanding the set of investment opportunities. Our evidence supports the real investment motive over the repurchase motive.

Keywords: stock liquidity, cash holdings, investment opportunities, external financing costs

JEL Classification: G31, G32, G12