The Effect of Market Liquidity on the Company Value

Abstract

Market liquidity, as an important factor of making investment decisions, provides security for the investors and reduces the risk of not being able to close their positions without significant loss of financial assets. Less liquid market brings higher yields due to greater price volatility but withdraws a greater risk. Liquidity is considered a primary factor in the development of capital markets. Researches made in emerging markets showed that there was 80% correlation between the spread of purchasing and selling prices and market liquidity. With the reduction of difficulties in trading related to prices, volume, and market capitalization, the level of market liquidity increases. As cash flow and control rights of the company are essentially determined by company shares, the marketability of shares will undoubtedly play a decisive role in corporate governance, assessing the value and performances of the company. The purpose of this chapter is to show that market liquidity has a positive impact on the performance and operating profitability of the companies and thereby on the value of the companies. Empirical analysis proved that companies with more liquid shares, traded on more regular basis, had higher operating income which was increasing business value. Another basis for the growing performance of the companies with liquid shares is by increasing the incentive effects of managerial contract founded on performance. Information feedback on the market price of shares that managers and other shareholders are getting is responsible for the better performance of companies whose shares are quoted on the more liquid capital markets.