Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

(Hop HipldF0AV) #1

capital.Thesecondiscenteredontheliquidityoftheassets
owned by a firm.


Theliquidityorlackthereofofthesecuritiesissuedbyafirm
canhavesignificantconsequencesforalmosteveryaspectof
corporate finance.



  • Ifweacceptthepropositionthatthecostof equity
    includesapremium forilliquidity,lessliquidfirms
    willhave highercosts ofequity (and capital) than
    moreliquidfirms.Thereisalsosomeevidencethat
    they face higher issuance costs in raising capital.
    Using2,387seasonedequityofferingsfrom 1993 to
    2000,Butler,Grullon,andWeston(2002)findthat,
    aftercontrollingforotherfactors,investmentbanks
    chargelowerfeesto firmswithmoreliquidstocks.
    Theyalsofindthatthetimetocompleteaseasoned
    equity offering declines with the level of market
    liquidity.
    82

  • Turningtotheinvestmentdecision,theperceptionof
    illiquidity can have consequences for the types of
    investments thata firmwilltake.In general,firms
    withilliquidsecuritieswillbelesswillingtoinvestin
    long-term projects with significant negative cash
    flowsintheearlyyears,eveniftheseprojectshave
    positiveNPV,becauseoftheconcernthattheywill
    be unable to fund these cash flows.

  • Firms with liquidsecurities canalso afford to pay
    moreindividendsandretainlesscash,knowingthat
    they can always raise fresh capital (with low
    transactions costs) to fund shortfalls.

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