Liquidity and firm investment: Evidence for Latin America

This paper explores the relationship between firms' investment and stock market liquidity. Using a panel of Latin American firms, I find evidence that a higher trading volume and a higher industry-adjusted trading volume are associated with higher firm investment (PPE, Total Assets, and Inventory). This relationship is higher in episodes where the firm decides to issue shares, and it is also greater for firms with tighter financial constraints and better investment opportunities. This evidence is consistent with a mispricing channel, where firms issue and invest the proceeds to take advantage of low cost of capital, or with a cost channel, where liquidity is associated with lower issuance costs. Also, it is less related with an informational channel, where a liquid market helps a manager to take more efficient decisions, since this channel does not necessarily predict an increase in investment, but only more efficient investment.

► I study the relationship between firm's investment and stock market liquidity.
► This relationship is estimated for Latin American firms from 1990 to 2010.
► I find robust evidence that a higher turnover and a higher industry-adjusted turnover is associated with higher firm investment.
► This effect increases when the firm decides to issue shares.
► Also, this effect is greater for firms with bigger financial constraints and larger investment opportunities.