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

Abstract

The article examines the determinants, financial characteristics and the stock returns of Indian firms which held excessive liquidity during the post-meltdown period of 2008–2012 in the backdrop of an uncertain business environment. The research design is essentially based on a model developed by Opler, Pinkowitz, Stulz, and Williamson (1999) adjusted for variable specification necessitated by Indian conditions and data availability. The model is used to identify the transitory and persistent excess liquidity firms. Quarterly, bi-yearly and yearly stock returns of excess liquidity firms are compared with the returns of non-excess liquidity control firms. In India where banks play a major role in financing in view of the illiquid debt market, speculative motive plays a dominant role in holding excess liquidity. Build-up of excess liquidity arising from the relatively strong economic performance of earlier years is utilized conservatively to decrease leverage rather than gear up investment when investment opportunity is depressed due to a weak macroeconomic outlook and structural factors. Greater liquidity and longer holdings do not generate lesser returns for varying periods till 1 year compared to a portfolio of non-excess liquidity control firms. At variance with the existing literature the results indicate that marginal value of liquidity in terms of stockholders’ returns does not decline with higher or longer liquidity holding when the investment environment is unfavourable.