Stock Liquidity and Investment Efficiency: Evidence From Two Quasi-Natural Experiments in China

Abstract

Using two quasi-natural experiments 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. In addition, we show that enhanced stock liquidity increases institutional ownership, board independence, and price efficiency, especially for under-investing firms. These findings are highly consistent with feedback and incentive theories on the effects of stock liquidity on corporate investment and financing decisions. Our findings highlight externalities linked to the Chinese reforms and further substantiate the real effects of financial markets.

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

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