Liquidity, the Value of the Firm, and Corporate Finance

  • Yakov Amihud
  • Published 2012

Abstract

Until fairly recently, the theory of corporate finance has been based on the idea that a company’s market value is determined mainly by just two variables: the company’s expected aftertax operating cash flows or earnings, and the risk associated with producing them. While there is considerable disagreement about how to define and quantify this risk, the measures of risk that show up in most asset pricing and corporate finance valuation models reflect mainly the volatility of the operating cash flows. Consistent with this view of the market valuation process, the risks that get measured and managed in most corporate investment and financing decisions are those that stem mainly from the volatility of the firm’s cash flow or earnings stream. In this article, we argue that there is another important factor affecting a company’s value: the liquidity (and what we later describe as the “liquidity risk”) of the company’s own securities, its debt as well as its equity. A company’s securities are liquid to the extent they can be traded quickly and at low cost. During the recent financial crisis, the shortage in funding and great uncertainty about asset values led to a dramatic reduction in the provision of liquidity services by market participants—that is, traders and dealers. The resulting changes in liquidity contributed to a sharp drop in securities prices, of all kinds of bonds and notes as well as stocks, and to an increase in the cost of capital.

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Cite this paper

@inproceedings{Amihud2012LiquidityTV, title={Liquidity, the Value of the Firm, and Corporate Finance}, author={Yakov Amihud}, year={2012} }