Stock Markets Liquidity, Corporate Governance and Small Firms

Solomon Tadesse

No wp883, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan

Abstract: While the importance of equity markets as a vehicle for capital formation is well recognized, their role in providing economically valuable governance services, particularly to small and medium enterprises (SME), has not received much attention. The paper examines the role of public policy in promoting the governance role of secondary equity markets for the benefit of SMEs. The paper first outlines the mechanisms through which equity markets could promote good governance in small firms, showing that equity markets serve as a monitoring and control conduit for outsiders to enforce good governance at the firm. It then establishes that the ability of equity markets to deliver good governance is closely related to those markets’ liquidity, presenting further international evidence that firms supported by liquid equity markets realize improved economic performance. Thus, the governance services of secondary equity markets have real economic value to the firms. The paper then argues that public policy can have a positive impact on the effectiveness of equity markets in delivering governance services through enhancing market liquidity. It examines the impact on market liquidity of two significant U.S. Securities and Exchange Commission (SEC) regulatory reforms applied to The Nasdaq Stock Market: SEC’s ‘trade reporting’ rules of 1992, and SEC’s “order handling” reforms of 1997. The paper concludes that public policies that increase market transparency and efficiency—such as “trade reporting” requirements and better “order handling” rules—promote the effectiveness of the secondary equity markets in delivering corporate governance through increased market liquidity.

Keywords: Governance; Stock Markets and Liquidity (search for similar items in EconPapers)
JEL-codes: G1 G14 G18 G3 (search for similar items in EconPapers)
Pages: pages
Date: 2005-06-01
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Citations: View citations in EconPapers (1)

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