Effect of Stock Liquidity on the Firm's Investment and Production.

The article investigates how stock market liquidity influences corporate investment and production decisions. It finds that illiquidity raises firms' cost of capital, leading to reduced investment in capital assets, research and development (R&D), and inventory, a relationship that holds even for firms without financial constraints. Using exogenous liquidity-improving events—the 2001 decimalization and the 1997 Nasdaq reform—and instrumental variable estimation, the study confirms that improved market liquidity increases investment. Additionally, illiquidity induces firms to adopt less capital-intensive production processes characterized by higher marginal productivity of capital, greater labor input relative to capital, and lower operating leverage, indicating a shift toward variable costs. These findings suggest that secondary market liquidity has significant real effects on firms’ investment behavior and production choices, providing a rationale for regulatory reforms aimed at enhancing market liquidity.