Agency Costs and Strategic Speculation in the U.S. Stock Market

Abstract

This study shows theoretically and empirically that a firm's agency problems may affect its stock liquidity. We postulate that less uncertainty about suboptimal managerial effort may enhance liquidity provision -- by lowering dealers' perceived adverse selection risk from trading with better-informed speculators. Consistent with our theory, we find that the staggered adoption of antitakeover provisions across U.S. states in the 1980s and 1990s -- a plausibly exogenous shock reducing perceived effort uncertainty by unambiguously facilitating managerial agency -- improves the stock liquidity of affected firms relative to peer firms. This evidence suggests that firm-level agency considerations play a nontrivial role for the process of price formation in financial markets.