- Finally,theliquidityorlackthereofofsecuritiescan
have consequences for how management at
companiesgets compensated.Inrecent years,firms
have increasingly used both options and restricted
stocktocompensatemanagement.Totheextentthat
theunderlyingstock isilliquid,theoptionswillbe
worthlessandthefirmpresumablyhastooffermore
optionsorpaycashtogeneratethesameequivalent
compensation.
83
What aboutasset liquidity?A firmwith liquidassets may
makeverydifferentdecisionsthanafirmwithilliquidassets.
Ingeneral,firmswithliquidassetscanborrowmore(onthe
belief thattheycanalwayssellsome oftheirassetsin the
eventofacashshortfall)andbemoreflexiblewhenitcomes
tobothdividendandinvestmentpolicyforthesamereasons.
InastudyofL.A.Gear,afirmthatsawitsequityvaluedrop
from $1 billion in 1989 to zero in 1998, DeAngelo,
DeAngelo,andWruck(2000)concludedthatassetliquidity
cangivemanagerssubstantialdiscretion,especiallywhenthe
firm is in financial distress.
84
CONCLUSION
Illiquidity matters. Investors are generally willing to pay
higherpricesformoreliquidassetsthanforotherwisesimilar
illiquid assets. While this proposition is widely accepted,
thereissubstantial debateabouthowtomeasureilliquidity
andhowtoincorporateitintovalue.Inthischapter,webegan
by relating illiquidity to transactions costs; less liquid
investmentshavehighercostsoftransacting,especiallyifwe