Legal institutions and fragile financial markets

Abstract

This study investigates equity liquidity variation with a funding constraint across 38 countries and examines whether the effectiveness of a country’s legal institutions is systematically related to cross-country differences in fragile equity liquidity. Our results show that firms from countries with more extensive disclosure requirements tend to have lower liquidity shocks due to funding constraints, leading to higher firm value. This effect is stronger for ex-ante disclosures, especially for countries with a high level of openness and market volatility. Our empirical results are robust to the 2SLS regression model, the random effect regression model, the alternative measure of fragile equity liquidity, and the alternative measure of disclosure and enforcement variables. Our study provides a better understanding of the effect of information environments amidst periods of funding constraint.