Liquidity, Information Production, and Corporate Financing Decisions

This study examines the impact of stock liquidity on firms' corporate financing decisions. We show that improved liquidity increases the likelihood of net debt issuance, with no consistent impact on net equity issuance. The effect on debt financing is especially strong among firms with higher default risk. Moreover, enhanced liquidity reduces the cost of debt more than the cost of equity. To address endogeneity, we exploit two US tick-size reforms, yielding highly consistent results. These findings align with models of capital structure under uncertainty and information asymmetry, as liquidity improves information production, reducing both market and insider uncertainty about future cash flows, lowering default risk, and the cost of debt. Finally, we find that enhanced liquidity mitigates common uncertainty more effectively than it closes the information gap.