Stock market liquidity is key factor in firms’ decision to raise new capital

Why do firms raise more capital in some periods than in others? It is well-known that the amount of outside capital that firms raise on the stock market fluctuates a lot over time. But we have limited understanding of the causes of these fluctuations. A research team from Rotterdam School of Management, Erasmus University (RSM) led by Professor Mathijs van Dijk studied whether variation in stock market liquidity helps to explain variation in corporate equity issuance over time. The study showed that firms raise more equity capital when stock market liquidity has recently improved.

Potential determinants of equity issuance

Equity issuance in the form of both initial public offerings (IPOs) and seasoned equity offerings (SEOs) is considerably more intense in some years than in others. For example, IPOs are characterized by ’hot’ and ’cold’ periods. Prior research shows that economic conditions (such as GDP growth), capital market conditions (such as market volatility) and aggregate stock market valuation (as measured by, for example, the aggregate price-earnings ratio) play a role in explaining why equity issuance is higher in some periods than in others. But these factors still leave a lot of the time-variation unexplained.

Prof. Van Dijk explains: “We wanted to know whether stock market liquidity, defined as the ability to trade shares easily with little impact on the stock price, may also be an important determinant of equity issuance. Our intuition was that, when a firm’s shares trade in a less liquid market, investors will have to be given more of a discount to absorb the issuance of extra shares. So, equity issuance should be more costly for existing shareholders when the market is less liquid, since an increase in the supply of shares has a greater price impact under less liquid market conditions. As a result, we expected firms to issue less equity in less liquid markets. To investigate our hypotheses, we collected data on 10,000 IPOs and 35,000 SEOs in 37 countries over the period 1995-2014.”  

Stock market liquidity a powerful predictor

The main finding of the RSM study is that, indeed, recent changes in stock market liquidity (over the past one to four quarters) are a powerful predictor of changes in equity issuance around the world. In particular, firms tend to issue more equity following improvements in market liquidity.

“We show that this relation between changes in equity issuance and changes in stock market liquidity survives controlling for the general state of capital markets, aggregate economic activity, asymmetric information, sentiment, and market timing. Reverse causation is also unlikely to drive our results, since our study is done at the country level and equity issuance only represents a small fraction of outstanding equity at the country level. Strikingly, we find that stock market liquidity is as powerful in explaining variation in equity issuance as are popular proxies for managers ’timing’ the market when raising new equity capital,” said Prof. Van Dijk.

Profit- and loss-making firms

The study also sheds light on the nature of the mechanism underlying the relation between equity issuance and liquidity. “In particular, firms in poor financial condition may not be able to postpone an equity issue if they believe that it will be less costly in the future,” Van Dijk explained. “On the other hand, firms in good condition may have more flexibility in letting their choice to issue equity depend on the liquidity of the stock market. In line with this intuition, we find that our results are weaker for loss making firms.”

Differences across countries

The study also examined whether its results are more prominent in some countries than in others, as the ease with which firms can issue equity varies across different countries. “Our key finding here was that the relation between equity issuance and liquidity is much stronger in more financially developed countries. This result suggests that firms are able to issue equity more rapidly in these countries to exploit favorable liquidity conditions.”

Impact on financial policies

Overall, the results indicate that the liquidity of stock market affects the costs of raising new equity capital, and that firms incorporate these costs into their decision whether or not to raise new equity. Prior research had shown that stock market liquidity affects trading costs, stock prices, and the performance of investment strategies. This study is among the first to show that stock market liquidity can also have consequences in the real economy, by affecting the amount of capital raised by firms that is available to finance corporate investment.Read the blog "Do Firms Issue More Equity When Markets Become More Liquid?" in Harvard Law School Forum.

Read the full paper “Do firms issue more equity when markets become more liquid? in Journal of Financial Economics.

About the researchers

Rogier Hanselaar is a PhD graduate in finance from RSM; René M. Stulz is the Everett D. Reese Chair of Banking and Monetary Economics at the Fisher College of Business at The Ohio State University; and Mathijs van Dijk is professor of finance at RSM.

To learn more about finance look into RSM’s open courses on finance and accounting.

Rotterdam School of Management, Erasmus University (RSM) is one of Europe’s top 10 business schools. RSM provides ground-breaking research and education furthering excellence in all aspects of management and is based in the international port city of Rotterdam – a vital nexus of business, logistics and trade. RSM’s primary focus is on developing business leaders with international careers who can become a force for positive change by carrying their innovative mindset into a sustainable future. Our first-class range of bachelor, master, MBA, PhD and executive programmes encourage them to become critical, creative, caring and collaborative thinkers and doers. Study information and activities for future students, executives and alumni are also organised from the RSM office in Chengdu, China.  

For more information about RSM or this release, please contact Irene Bosman, communications manager for RSM, on +31 10 408 2028 or by email at

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