Liquidity and Governance

Abstract

Is greater trading liquidity good or bad for corporate governance? We address this question both theoretically and empirically. We solve a model consisting of an optimal IPO followed by a dynamic Kyle market in which the large investor's private information concerns her own plans for taking an active role in governance. We show that an increase in the liquidity of the firm's stock increases the likelihood of the large investor 'taking the Wall Street walk.' Thus, higher liquidity is harmful for governance. Empirical tests using three distinct sources of exogenous variation in liquidity confirm the negative relation between liquidity and blockholder activism.

Investment and financing decisions of private and public firms

“…They argue that this ‘dark side’ of liquidity reduces incentives for shareholders to monitor, and, eventually, induces managers to engage in empire‐building behavior. Back, Li, and Ljungqvist () report that blockholder activity, as measured by hedge fund activism and the number of shareholder proposals submitted in opposition to management, decreases when liquidity increases.…”

Corporate Governance and Blockchains

“…Admati and Pfleiderer (2009) present a model in which the threat of exit deters managers from accepting non-value maximizing projects that have private benefits. An empirical study by Back, Li and Ljungqvist (2015) finds increased use of the voice mechanism after exogenous shocks that reduce liquidity (the closure of brokerages) and decreased use of voice after shocks that increase liquidity (mergers of retail brokers with institutional brokers).…”

Activism, Strategic Trading, and Liquidity

“…9 A generalization of our model would be to allow the cost to depend on the blockholding x as C(v, x). Such a model was studied in one of our previous papers (Back, Li and Ljungqvist, 2015). In that model, the asset value is binary with possible values vL < vH , the cost of generating the high value is c, and activism cannot be successful…”

“…Example 4 (Binary). This example is from Back, Li and Ljungqvist (2015). The model of activism is the same as that studied in the context of a single-period Kyle model by Maug (1998).…”