•  
  •  
 

Abstract

This study investigates the effect of stock liquidity on the risk of stock price crashes, taking sample of non-financial firms listed on the Pakistan Stock Exchange, from 2009 to 2024. A two-step system GMM estimation is applied to test the hypotheses. The results reveal that greater stock liquidity significantly reduces crash risk, whereas illiquidity amplifies it. Two underlying channels explain this relationship; first, liquidity strengthens block holders’ capacity to intervene, discouraging managerial tendencies to withhold adverse information, second, liquidity enhances price informativeness, limiting managerial discretion to manipulate prices through delayed disclosure of bad news. The findings imply that liquid stocks not only improve internal governance but also contribute to market stability. These insights support regulatory measures aimed at fostering liquidity, as a means of mitigating extreme downside risks in equity markets.

References

Ali, S., Liu, B., & Su, J. J. (2016). What determines stock liquidity in Australia?. Applied Economics, 48(35), 3329-3344.

Alp, O. S., Canbaloglu, B., & Gurgun, G. (2022). Stock liquidity, stock price crash risk, and foreign ownership. Borsa Istanbul Review, 22(3), 477-486.

Amihud, Y., & Mendelson, H. (2006). Stock and bond liquidity and its effect on prices and financial policies. Financial Markets and Portfolio Management, 20(1), 19.

Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects. Journal of financial markets, 5(1), 31-56.

An, H., & Zhang, T. (2013). Stock price synchronicity, crash risk, and institutional investors. Journal of Corporate Finance, 21, 1-15.

Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The review of economic studies, 58(2), 277-297.

Ball, R. (2009). Market and political/regulatory perspectives on the recent accounting scandals. Journal of accounting research, 47(2), 277-323.

Benmelech, E., Kandel, E., & Veronesi, P. (2010). Stock-based compensation and CEO (dis) incentives. The Quarterly Journal of Economics, 125(4), 1769-1820.

Ben-Nasr, H., & Ghouma, H. (2018). Employee welfare and stock price crash risk. Journal of Corporate Finance, 48, 700-725

Bharath, S. T., Jayaraman, S., & Nagar, V. (2013). Exit as governance: An empirical analysis. The Journal of Finance, 68(6), 2515-2547.

Bhide, A. (1993). The hidden costs of stock market liquidity. Journal of financial economics, 34(1), 31-51.

Bleck, A., & Liu, X. (2007). Market transparency and the accounting regime. Journal of accounting research, 45(2), 229-256.

Bloomfield, R., O’hara, M., & Saar, G. (2009). How noise trading affects markets: An experimental analysis. The Review of Financial Studies, 22(6), 2275-2302.

Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of econometrics, 87(1), 115-143.

Blundell, R., & Bond, S. (2000). GMM estimation with persistent panel data: an application to production functions. Econometric reviews, 19(3), 321-340.

Bonaimé, A. A., Öztekin, Ö., & Warr, R. S. (2014). Capital structure, equity mispricing, and stock repurchases. Journal of Corporate Finance, 26, 182-200.

Bowen, R. M., Rajgopal, S., & Venkatachalam, M. (2008). Accounting discretion, corporate governance, and firm performance. Contemporary accounting research, 25(2), 351-405.

Chang, X., Chen, Y., & Zolotoy, L. (2017). Stock liquidity and stock price crash risk. Journal of financial and quantitative analysis, 52(4), 1605-1637.

Calcagno, R., & Heider, F. (2007). Market-based compensation, price informativeness and short-term trading.

Callen, J. L., & Fang, X. (2015). Religion and stock price crash risk. Journal of Financial and Quantitative Analysis, 50(1-2), 169-195.

Cao, F., Ye, K., Zhang, N., & Li, S. (2018). Trade credit financing and stock price crash risk. Journal of International Financial Management & Accounting, 29(1), 30-56.

Chang, X., Chen, Y., & Zolotoy, L. (2017). Stock liquidity and stock price crash risk. Journal of financial and quantitative analysis, 52(4), 1605-1637.

Chauhan, Y., Kumar, S., & Pathak, R. (2017). Stock liquidity and stock prices crash-risk: Evidence from India. The North American Journal of Economics and Finance, 41, 70-81.

Chauhan, Y., Wadhwa, K., Syamala, S. R., & Goyal, A. (2015). Block-ownership structure, bank nominee director and crash-risk. Finance Research Letters, 14, 20-28.

Chen, J., Chan, K. C., Dong, W., & Zhang, F. (2017). Internal control and stock price crash risk: Evidence from China. European Accounting Review, 26(1), 125-152.

Chen, J., Hong, H., & Stein, J. C. (2001). Forecasting crashes: Trading volume, past returns, and conditional skewness in stock prices. Journal of financial Economics, 61(3), 345-381.

Chordia, T., Goyal, A., Sadka, G., Sadka, R., & Shivakumar, L. (2009). Liquidity and the post-earnings-announcement drift. Financial Analysts Journal, 65(4), 18-32.

Chauhan, Y., Kumar, S., & Pathak, R. (2017). Stock liquidity and stock prices crash-risk: Evidence from India. The North American Journal of Economics and Finance, 41, 70-81.

Coffee Jr, J. C. (1991). Liquidity versus control: The institutional investor as corporate monitor. Colum. L. Rev., 91, 1277.

Cohen, L. J., Cornett, M. M., Marcus, A. J., & Tehranian, H. (2014). Bank earnings management and tail risk during the financial crisis. Journal of Money, Credit and Banking, 46(1), 171-197.

Conrad, J., Dittmar, R. F., & Ghysels, E. (2013). Ex ante skewness and expected stock returns. The Journal of Finance, 68(1), 85-124.

Dang, V. A., Lee, E., Liu, Y., & Zeng, C. (2018). Corporate debt maturity and stock price crash risk. European Financial Management, 24(3), 451-484.

Dasgupta, S., Gan, J., & Gao, N. (2010). Transparency, price informativeness, and stock return synchronicity: Theory and evidence. Journal of Financial and Quantitative analysis, 45(5), 1189-1220.

Davidson, R., & MacKinnon, J. G. (2004). Econometric theory and methods (Vol. 5, pp. 189-196). New York: Oxford University Press.

Dimson, E. (1979). Risk measurement when shares are subject to infrequent trading. Journal of Financial Economics, 7(2), 197-226.

Durnev, A., Morck, R., Yeung, B., & Zarowin, P. (2003). Does greater firm‐specific return variation mean more or less informed stock pricing?. Journal of Accounting research, 41(5), 797-836.

Easley, D., & O'hara, M. (2004). Information and the cost of capital. The journal of finance, 59(4), 1553-1583.

Edmans, A., & Manso, G. (2011). Governance through trading and intervention: A theory of multiple blockholders. The Review of Financial Studies, 24(7), 2395-2428.

Edmans, A. (2009). Blockholder trading, market efficiency, and managerial myopia. The Journal of Finance, 64(6), 2481-2513.

Edmans, A., Fang, V. W., & Zur, E. (2013). The effect of liquidity on governance. The Review of Financial Studies, 26(6), 1443-1482.

Fang, V. W., Tian, X., & Tice, S. (2014). Does stock liquidity enhance or impede firm innovation?. The Journal of finance, 69(5), 2085-2125.

Farooq, U., Ahmed, J., & Khan, S. (2021). Do the macroeconomic factors influence the firm's investment decisions? A generalized method of moments (GMM) approach. International Journal of Finance & Economics, 26(1), 790-801.

Ferreira, D., Ferreira, M. A., & Raposo, C. C. (2011). Board structure and price informativeness. Journal of Financial economics, 99(3), 523-545.

Francis, B., Hasan, I., & Li, L. (2016). Abnormal real operations, real earnings management, and subsequent crashes in stock prices. Review of Quantitative Finance and Accounting, 46, 217-260.

Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: which factors are reliably important?. Financial management, 38(1), 1-37.

Gaud, P., Jani, E., Hoesli, M., & Bender, A. (2005). The capital structure of Swiss companies: an empirical analysis using dynamic panel data. European financial management, 11(1), 51-69.

Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of accounting and economics, 40(1-3), 3-73.

Greene, J., & Smart, S. (1999). Liquidity provision and noise trading: Evidence from the “investment dartboard” column. The Journal of Finance, 54(5), 1885-1899.

Grossman, S. J., & Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. The American economic review, 70(3), 393-408.

Habib, A., & Huang, H. J. (2019). Abnormally long audit report lags and future stock price crash risk: evidence from China. International Journal of Managerial Finance.

Harvey, C. R., & Siddique, A. (2000). Conditional skewness in asset pricing tests. The Journal of finance, 55(3), 1263-1295.

Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of accounting and economics, 31(1-3), 405-440.

Holden, C. W., Jacobsen, S., & Subrahmanyam, A. (2014). The empirical analysis of liquidity. Foundations and Trends® in Finance, 8(4), 263-365.

Holmström, B., & Tirole, J. (1993). Market liquidity and performance monitoring. Journal of Political economy, 101(4), 678-709.

Huang, J., & Wang, J. (2009). Liquidity and market crashes. The Review of Financial Studies, 22(7), 2607-2643.

Huma, S., Ahmed Siddiqui, D., & Ahmed, W. (2023). Understanding the impact of Green supply chain management practices on operational competitive capabilities. The TQM Journal, 35(3), 796-815.

Hutton, A. P., Marcus, A. J., & Tehranian, H. (2009). Opaque financial reports, R2, and crash risk. Journal of financial Economics, 94(1), 67-86.

Jayaraman, S., & Milbourn, T. T. (2012). The role of stock liquidity in executive compensation. The Accounting Review, 87(2), 537-563.

Jin, L., & Myers, S. C. (2006). R2 around the world: New theory and new tests. Journal of financial Economics, 79(2), 257-292.

Khan, B., Tahir, M., Nasir, A. M., & Mushtaq, M. (2019). The impact of companies' internal factors on stock liquidity in Pakistan. Afro-Asian Journal of Finance and Accounting, 9(4), 459-473.

Kim, J. B., & Zhang, L. (2014). Financial reporting opacity and expected crash risk: Evidence from implied volatility smirks. Contemporary Accounting Research, 31(3), 851-875.

Kim, J. B., & Zhang, L. (2016). Accounting conservatism and stock price crash risk: Firm‐level evidence.Contemporary accounting research, 33(1), 412-441.

Kim, J. B., Li, Y., & Zhang, L. (2011). Corporate tax avoidance and stock price crash risk: Firm-level analysis. Journal of financial Economics, 100(3), 639-662.

Kim, J. B., Wang, Z., & Zhang, L. (2016). CEO overconfidence and stock price crash risk. Contemporary Accounting Research, 33(4), 1720-1749.

Kothari, S. P., Shu, S., & Wysocki, P. D. (2009). Do managers withhold bad news?. Journal of Accounting research, 47(1), 241-276.

Kothari, S. P., Shu, S., & Wysocki, P. D. (2009). Do managers withhold bad news?. Journal of Accounting research, 47(1), 241-276.

Kraus, A., & Stoll, H. R. (1972). Price impacts of block trading on the New York Stock Exchange. The Journal of Finance, 27(3), 569-588.

Lee, M. T., & Nien, K. T. (2019). Does D&O insurance matter for stock price crash risk? Evidence from an Asian emerging market. Journal of Capital Markets Studies.

Lee, M. T. (2016). Corporate social responsibility and stock price crash risk: Evidence from an Asian emerging market. Managerial Finance, 42(10), 963-979.

Liu, M. H. (2012). Idiosyncratic Return Volatility and Price Informativeness: Evidence from Stock Splits. Available at SSRN 2021320.

Matsumoto, D. A. (2002). Management's incentives to avoid negative earnings surprises. The accounting review, 77(3), 483-514.

Maug, E. (1998). Large shareholders as monitors: Is there a trade‐off between liquidity and control?. The journal of finance, 53(1), 65-98.

Norli, Ø., Ostergaard, C., & Schindele, I. (2015). Liquidity and shareholder activism. The Review of Financial Studies, 28(2), 486-520.

O'Hara, M. (2004). Liquidity and financial market stability. National Bank of Belgium Working Paper, (55).

Rasheed, M. S., & Kouser, S. (2020). Corporate Governance and Stock Price informativeness: Evidence from an Emerging Market. Journal of Accounting and Finance in Emerging Economies, 6(2), 593-605.

Rehman, I. U., Mahdzan, N. S., & Zainudin, R. (2016). Is the relationship between macroeconomy and stock market liquidity mutually reinforcing? Evidence from an emerging market. International Journal of Monetary Economics and Finance, 9(3), 294-316.

Roll, R. (1988). The international crash of October 1987. Financial analysts journal, 44(5), 19-35.

Rubinstein, M. E. (1973). The fundamental theorem of parameter-preference security valuation. Journal of Financial and Quantitative Analysis, 8(1), 61-69.

SALEEM, S., & USMAN, M. (2021). Information risk and cost of equity: The role of stock price crash risk. The Journal of Asian Finance, Economics and Business, 8(1), 623-635.

Saleem, S., Usman, M., & ul Haq, M. A. (2018). Impact of Business Strategy on Stock Price Crash Risk: Role of Overvalued Equity. NICE Research Journal, 112-129.

Scholes, M. S. (1972). The market for securities: Substitution versus price pressure and the effects of information on share prices. The Journal of Business, 45(2), 179-211.

Sias, R. W., Starks, L. T., & Titman, S. (2006). Changes in institutional ownership and stock returns: Assessment and methodology. The Journal of Business, 79(6), 2869-2910.

Sibarani, J. S. (2018). THE EFFECT OF TAX AVOIDANCE AND STOCK LIQUIDITY TO THE STOCK PRICE CRASH RISK (Doctoral dissertation, President University).

Uppal, J. Y. (2006). Regulatory Response to Market Volatility and Manipulation: A Case Study of Mumbai and Karachi Stock Exchanges Jamshed Y. Uppal and Inayat U. Mangla. Lahore Journal of Economics, 11(2), 79-105.

Tetlock, P. C. (2007). Does liquidity affect securities market efficiency. University of Texas.

Shleifer, A., & Vishny, R. W. (1986). Large shareholders and corporate control. Journal of political economy, 94(3, Part 1), 461-488.

Vo, X. V. (2017). Do foreign investors improve stock price informativeness in emerging equity markets? Evidence from Vietnam. Research in International Business and Finance, 42, 986-991.

Wooldridge, J. M. (2002). Inverse probability weighted M-estimators for sample selection, attrition, and stratification. Portuguese economic journal, 1(2), 117-139.

Yeung, W. H., & Lento, C. (2018). Ownership structure, audit quality, board structure, and stock price crash risk: Evidence from China. Global Finance Journal, 37, 1-24.

Zhang, H., Arda, B., Lu, Y., & Miao, S. (2018). Stock liquidity and price crash risk: Evidence from a Kernel matching approach. Annals of Economics and Finance, 19(2), 653-681.

Zia, H., & Siddiqui, D. A. (2019). Stock Liquidity and Real Economic Activities-Evidence from Karachi Stock Exchange. SSRN.

Download

Share

COinS
 
 

To view the content in your browser, please download Adobe Reader or, alternately,
you may Download the file to your hard drive.

NOTE: The latest versions of Adobe Reader do not support viewing PDF files within Firefox on Mac OS and if you are using a modern (Intel) Mac, there is no official plugin for viewing PDF files within the browser window.