Stock liquidity and capital allocation efficiency: Evidence from Chinese listed companies

Based on market microstructure theories and evidence, this paper investigates the relationship between stock liquidity and capital allocation efficiency using Chinese listed companies from 1998 to 2011. This paper finds that stock liquidity helps improve investment efficiency, mitigating both overinvestment and underinvestment. This finding is robust to numerous sensitivity analyses, including controls for endogeneity and for the other known determinants of investment efficiency, the choice of the measure of stock liquidity and investment efficiency. Further analysis shows that stock liquidity improves corporate capital allocation efficiency by reducing agency costs and increasing the information content of share prices.