Excessive Corporate Liquidity and Stock Return: Evidence from Indian Business Environment

Abstract

Purpose: The paper examines the determinants, financial characteristics and the stock returns of the Indian firms holding excessive liquidity during post-meltdown period of 2008-12. Design/methodology/approach: The research design is essentially based on fixed effect model developed by Opler, Pinkowitz, Stulz and Williamson (1999) adjusted for variable specification necessitated by Indian condition and data availability. The model is used to identify the transitory’ and persistent excess liquidity firms. The financial characteristics, quarterly, bi-yearly and yearly stock returns of transitory, persistent excess liquidity firms and non-excess liquidity control firms are compared and analyzed. Findings & Conclusion: In India where banks play a major role in financing in view of illiquid debt market, speculative motive plays a dominant role in holding excess liquidity. Build up of excess liquidity arising from relatively strong economic performance of earlier years is utilised conservatively to decrease leverage rather than to gear up investment when investment opportunity is depressed due to weak macroeconomic outlook and structural factors. Greater liquidity holding does not translate into higher returns for varying periods till one year compared to a portfolio of non-excess cash control firms. But persistent high liquidity firms produce superior return than the return of transitory high liquidity firms. At variance with existing literature the results indicate that marginal value of liquidity does not decline with higher or longer liquidity holding when investment environment is unfavourable.