The Corporate Governance Program

Liquid ownership and the cost of capital

A key finding in the market microstructure literature is that the liquidity of the securities market impacts the firm's cost of capital. For example, Brennan, Chordia, and Subrahmanyam (1998) show that the annual expected return of Nasdaq stocks decreases by 3.5 percentage points when liquidity increases by one standard deviation. Other evidence from the U.S. shows that ownership characteristics such as the fraction of insider ownership, institutional holdings, and ownership concentration are strongly related to stock liquidity.

The purpose of this project is to explore these relationships in the Norwegian equity market. This project differs from the breadth project by being much more focused on the trading mechanisms, making extensive use of microstructure data on trading interest and trading activity. The supervisory department of the Oslo Stock Exchange (OSE) has given us access to the complete records of trades and quotes over the period 1999-2001. This very detailed data set allows us to carry out the research using the tools of modern market microstructure theory.

The microstructure data will be used to characterize the liquidity of ownership rights at the OSE. We then go on to explore the effect of reduced liquidity on the firm's cost of capital. Much attention will be paid to the determinants of liquidity, focusing on ownership structure characteristics in particular. Our comprehensive data base of ownership characteristics enables us to relate ownership and liquidity in a way which has not been done in the literature so far. The use of the OSE microstructure data may be particularly advantageous. This is because the expected liquidity effect is stronger and thus easier to identify in the smaller, more insider-dominated Norwegian equity market than in the larger markets in the UK and the US, where most of the existing empirical research has been carried out.
The findings from this research is presented in the following paper:

As part of this project the conference Conference on the Microstructure of Equity and Currency Markets was organized jointly with Norges Bank. Follow this the link to the conference Homepage .

Note: A followup conference is organized by the Bank of Canada: Microstructure of Foreign Exchange and Equity Markets - 20 and 21 October 2006