The Impact of Corporate Governance and Earnings Management on Stock Market Liquidity in a Highly Concentrated Ownership Capital Market

We provide insights to the effects of corporate governance mechanisms and earnings management on market liquidity (measured by bid–ask spreads [B_As] and trading volume) in a setting characterized by highly concentrated noninstitutional ownership. First, we document that high noninstitutional ownership increases B_As and depresses trading volumes. Next, we show that volume of trade tends to be higher and B_A tends to be lower for firms with better corporate governance mechanisms (e.g., board independence and CEO–chairman separation) when there is high concentration of noninstitutional ownership. In contrast to prior findings, when controlling for corporate governance quality, B_As are unaffected by earnings management, while trading volume increases when earnings management is higher, presumably due to an increase in investor disagreement. Our results are robust to changes in the market trading system across the sample period.