Corporate Governance and Market Liquidity

Abstract

This paper investigates how corporate decisions such as the choice of corporate governance mechanisms or information disclosure by management, affect firm stock liquidity. The model studies the interaction between a firm's manager and its shareholders and shows that the quality of the firm's dividend report, a result of this interaction, affects information asymmetry in the financial market, and therefore, liquidity. Interestingly, the effect of disclosure quality on liquidity is non-monotonical. The model also highlights the complementarity between internal and external corporate governance mechanisms. Thus, the optimal level of disclosure required to maximize market liquidity increases in the quality of the firm's internal corporate governance mechanisms.