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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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IMPLICATIONS OF STOCK ILLIQUIDITY

About 1,815 U.S. public stocks have ADTV of less than $1 million or a float of less than $150 million. Stock illiquidity is found in most industries but is especially prevalent in the financial and technology sectors. Many illiquid stocks are smaller companies, but others are American Depositary Receipts (ADRs), dual-class shares, stocks with large inside ownership positions, and other stocks with unique ownership profiles.

Given the size and prevalence of a liquidity discount, the policy implications of stock liquidity are far reaching. They are equally applicable, and potentially even more compelling, for non-U.S. exchanges, where liquidity may be more problematic.

Optimal Capital Structure

Traditional capital structure considerations may need to be subordinated to the overriding concern of liquidity. Leverage policy objectives could include raising equity to enhance stock liquidity. Cash policies will be oriented toward building and maintaining large balances to counter the cost and difficulties associated with market access.

Disclosure

Illiquid companies may be able to lower their cost of equity through enhanced reporting, disclosure, and investor communications.7

Shareholder Distributions

Shareholder distributions (dividends and share repurchases) may represent wasted equity for the illiquid stock. However, though too large a share repurchase program risks further eroding the float; a small program (e.g., 1 percent per year) can enhance liquidity ...

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