Investor Protection and the Value Impact of Stock Liquidity

This paper investigates the effect of investor protection on the value impact of stock liquidity. Using a sample of firms from 41 countries for the period between 1996 and 2010, we show that investor protection is positively associated with the value impact of stock liquidity. This association is robust to various endogeneity tests including a difference-in-differences approach based on a natural experiment and a country-level analysis. Further evidence shows that strong investor protection increases the value impact of liquidity by reducing managerial entrenchment, encouraging informed trading, and enhancing pay-for-performance sensitivity