Do Firms Choose Their Stock Liquidity? A Study of ...sofie2012/slides/Xiao.pdf · Do Firms Choose...
Transcript of Do Firms Choose Their Stock Liquidity? A Study of ...sofie2012/slides/Xiao.pdf · Do Firms Choose...
Do Firms Choose Their Stock Liquidity?
A Study of Innovative Firms and Their
Stock Liquidity
Nishant Dass
Vikram Nanda
Steven C. Xiao
Motivation
Stock liquidity is a desirable feature for some firms
Higher liquidity is associated with lower expected return on
assets and thus lower cost of capital (Amihud and
Mendelson,1986)
Liquid stock, which incorporates more information in the
price, plays a stronger role in monitoring the managers
(Holmström and Tirole, 1993)
However, not every firm may want or need liquidity –
facilitates market for corporate control; leakage of
proprietary information..
Motivation
Firms can adopt liquidity-enhancing policies to
improve liquidity
- Amihud and Mendelson (2000) suggest a number
of means to increase stock liquidity including
increasing investor base and reducing information
asymmetry.
- Many papers have linked changes in liquidity to
firm actions such as equity issuance
Motivation
However, evidence documenting the efforts of
firms to improve the stock liquidity is lacking
We ask whether firms choose stock liquidity
by studying a group of firms that, we contend,
are more reliant on equity financing:
innovative firms
Motivation
Firms with focus on innovation produce unique
products
– Firms with unique products will have greater ripple
effects of bankruptcy on their customers, suppliers,
and workers. (Titman, 1984; Titman, Wessels, 1988)
Innovative firms tend to have more intangible assets
which have lower collateral value
Therefore, innovative firms will have lower leverage
ratios and more reliant on equity financing
Motivation
We classify firms as innovative either by their
investments in R&D or number of patents/citations
Intuitively, one would expect innovative firms to
have lower stock liquidity as their assets are
informationally more opaque to the market
However, we find that innovative firms are positively
associated with stock liquidity, suggesting that these
firms might be taking deliberate actions to improve
their stock liquidity.
Motivation: Summary of Findings
We identify that innovative firms indeed take actions that are
known to improve liquidity:
- Issue more frequent guidance (Coller and Yohn, 1997)
- More likely to do stock splits (Muscarella and Vetsuypens, 1996;
Lin, Singh and Yu, 2009)
- More likely to make SEOs (Eckbo et al., 2000; and Kothare,
1997)
- More likely to hire reputed underwriter (Amihud and
Mendelson, 1988; Ellis, Michaely and O’Hara, 2000)
- More likely to have option listed (Mayhew and Mihov, 2004)
More importantly, these actions do help innovative firms
improve their stock liquidity
Motivation: Summary of Findings (cont)
An exogenous increase in liquidity improves firm value
and such effect is stronger for innovative firms
- we find that this stronger effect is concentrated among
innovative firms with more equity-based compensation
Innovative firms are more likely to have access to
public debt, higher credit rating, and fewer
(quantitative) covenants in bank loans
The role of monitoring is taken by equity holders
- Innovative firms are associated with higher institutional
ownership, higher likelihood of a blockholder, and higher
equity-based compensation for managers
Hypotheses
H1: Innovative firms have greater stock liquidity but
less so when they have access to alternative sources
of capital or less financially constrained
H2: Innovative firms will take deliberate actions that
are known to improve stock liquidity
H3: The impact of a marginal increase in liquidity on
value (Tobin’s Q) would be greater for innovative
firms
Data: Dependent Variables
Four proxies for stock illiquidity
Amihud’s (2002) Illiquidity:
Negative Turnover:
Data: Dependent Variables
Bid-Ask Spread:
Probability of Informed Trading (PIN) by Easley, Kiefer,
O’Hara, and Paperman (1996)
Data: Innovativeness
R&D: ratio of R&D expenditure to lagged assets
Log Patent: log( 1 + number of patents/100)
Log Citation: log( 1 + number of citations/100)
Innovation Index: first principal component of the
correlation matrix for the three innovativeness measures.
Empirical Analysis: H1
To confirm the negative association between
innovativeness and illiquidity, we estimate the
following model:
Firm characteristics includes: Log Assets, Leverage, Cash,
Tobin’s Q, NYSE Dummy, ROA, Tangibility, Firm’s Age,
Return Volatility
Empirical Analysis: H1
H1: Innovative firms have greater stock liquidity but
less so when they have access to alternative sources
of capital
Test whether relationship between innovativeness and
illiquidity is weaker when firms have access to public
debt, high market power, and pay dividend:
Empirical Analysis: H2
H2: Innovative firms will take deliberate actions that
are known to improve stock liquidity
We test whether innovative firms issue more frequent
earnings guidance, more likely to have stock splits,
more likely to make SEOs, and more likely to hire
reputed underwriter
Empirical Analysis: H2
H2: Innovative firms will take deliberate actions that
are known to improve stock liquidity
We test whether these actions indeed improve stock
liquidity
We instrument actions with industry median (or
mean) of these action variables to rule out
endogenous decisions
Empirical Analysis: H3
H3: The impact of a marginal increase in liquidity on
value (Tobin’s Q) would be greater for innovative
firms
We test whether an exogenous change in illiquidity
negatively impact Tobin’s Q
First, instrument change in illiquidity with median
change in illiquidity of the industry
Empirical Analysis: H3
Second, we look at an exogenous shocks to the firms’
stock illiquidity -- decimalization
Specifically, we test whether change in illiquidity
surrounding decimalization negatively impact firm
value
Empirical Analysis: Debt of Innovative Firms
What type of debt financing do innovative firms
prefer?
We argue that attempts of innovative firms at
mitigating the information asymmetry in stock
market benefit them in the debt markets
Firm also lower the information asymmetry by
generating information in the public debt markets
Due to lower leverage ratio, innovative firms should
receive favorably from creditors
Empirical Analysis: Debt of Innovative Firms
We find that innovative firms:
- Are more likely to have public debt
- Higher credit rating
- Fewer (quantitative) loan covenants
Empirical Analysis: Who Monitors Innovative Firms?
Innovative firms have lower leverage ratio and
fewer covenants in their bank loans
Due to reliance on equity financing, equity
holders assume the role of monitoring
We find that innovative firms have greater
institutional ownership, more likely to have
blockholders, and higher equity-based
compensation
Empirical Analysis: Does Incentive Contract Help?
Innovative firms, whose assets and managers’ decisions
are more opaque, benefit more from incentive contract
We examine whether value effect of liquidity is greater
for innovative firms with high equity-based
compensation
We test this again with the exogenous shock to liquidity
(decimalization)
Concluding Remarks
Innovative firms are positively associated with
stock liquidity
Innovative firms take actions to improve
liquidity and these actions do work
Innovative firms benefit more than others by
having higher stock liquidity in terms of firm
value
Concluding Remarks
Innovative firms return to public capital
markets, which helps reduce information
asymmetry; their private debt is less likely to
have covenant or fewer covenants if any
Equity-holders assume the role of monitoring
innovative firms
As innovative firms have greater incentive
contract, an exogenous decrease in illiquidity
increases firms’ value more than other firms,
consistent with the argument of Holström and
Tirole