The Effect of Stock Liquidity on Debt-Equity Choices

We examine the effect of stock liquidity on the choice between debt and equity financing. Using three quasi-natural experiments, we show that increased stock liquidity increases firms' propensity to finance using debt. In addition, we document that liquidity reduces the cost of debt finance. Taken together, these results suggest that increased liquidity, by increasing security market information production, reduces insider and market uncertainty about future firm cash flows and thereby increases the attractiveness of debt financing