Stock Liquidity and Leverage : The Role of Debt Security, Financial Constraint, and Risk Around the Financial Crisis

This study examines the heterogeneity of liquidity effect on leverage and the propensity of zero leverage. Using U.S. public firms from 1990 to 2017, we demonstrate that the stock liquidity has significantly negative effects on total debt and secured debt while insignificant effects on unsecured debt. Such liquidity effect became much weaker after the 2007-2008 financial crisis. We also provide the first evidence that stock liquidity increases the likelihood of zero leverage. Furthermore, we test two potential economic mechanisms and find that the liquidity effects are stronger for companies with high financial constraints and business risk. Our results are robust to various measures of leverage and control for endogeneity. Overall, our results show a significant heterogeneity of liquidity effect on leverage with various levels of security and across different time periods around the financial crisis