Strategic Corporate Finance: Applications in Valuation and Capital Structure

SOLUTIONS TO ILLIQUIDITY

There are many potential capital market solutions to stock liquidity problems, including primary and secondary issuance, block trades, and stock splits, but their impact on stock liquidity and excess returns are different. The impact for illiquid stocks is different than the impact for liquid stocks.9

Primary Issuance

Of the capital market tactics evaluated, primary issuance exhibited the greatest benefit to stock liquidity. The ADTV of illiquid stocks increases 200 percent, yet the ADTV of liquid stocks improves only about 6 percent. For 32 percent of the illiquid stocks, liquidity is sufficiently enhanced to warrant reclassification to a liquid stock. Of 1,281 non-IPO primary issues from the period 2000 to 2005, 203 were illiquid, but 65 of these were made sufficiently liquid within 45 days of offer to warrant reclassification to liquid.

Improved liquidity is associated with excess returns. For illiquid stocks, primary issuance has been associated with positive excess returns of 22 percent, or 14 percent more than the 8 percent baseline for liquid stocks (liquid and illiquid excess returns significant at 99 percent confidence level; difference significant at 80 percent). Though liquidity improved and excess returns were positive, use of proceeds is still a key factor to stock performance in primary offerings. Any uncertain or potentially unpopular use of proceeds can send a negative signal to the market and impair the stock price.

Primary Issuance and ...