In our paper, The Effect of Liquidity on Governance, which was recently made publicly available on SSRN, we study how stock liquidity affects whether and how blockholders choose to exert governance on a firm. We find that liquidity encourages shareholders to acquire blocks (stakes of at least 5%). Conditional upon a block being formed, liquidity discourages blockholders from governing through “voice” (intervention) as it increases the likelihood of them filing Schedule 13G (which conveys a passivist intent) rather than 13D (which conveys an activist intent). This switch has two interpretations: the blockholder is abandoning governance altogether, or instead is switching to the alternative governance mechanism of “exit” (informed trading of a firm’s shares, otherwise known as the “Wall Street Rule” or “Wall Street Walk”).

Our evidence supports the latter: the effect of liquidity on both block acquisition and the switch from 13D to 13G is stronger in firms where the manager is more sensitive to the stock price (and thus the threat of exit), and the market reaction to a 13G filing is significantly positive, particularly among firms with high liquidity. Thus, liquidity causes a switch from voice to exit rather than causing a blockholder to abandon governance altogether. Although liquidity reduces the frequency of voice, conditional on a block being formed, this is outweighed by the positive effect of liquidity on block formation to begin with. Thus, unconditionally, liquidity leads to an increase in both exit and voice and so we demonstrate an overall positive effect of liquidity on governance. We use decimalization as an exogenous shock to liquidity to identify causal effects.

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