Stock Liquidity and Investment Efficiency: Evidence from the Split-Share Structure Reform in China

Abstract

Using the split-share structure reform in China, we examine the effect of stock liquidity on investment efficiency. We find that enhanced stock liquidity leads to more efficient investment and the effect is much more pronounced for under-investing firms compared to over-investing firms. We also find that the increase in institutional ownership and price efficiency generated by the change in stock liquidity is positively associated with the reduction in under-investment. Taken together, these findings suggest that under-investing firms with liquid stocks have more informed investors and face higher pressure to select an optimal level of investment in the post-reform period.

Keywords: Stock liquidity, Investment efficiency, Institutional ownership, Information efficiency, Corporate governance

JEL Classification: G14, G15, G31, G34, D83