sectors.Theempiricalevidenceissupportiveofthis
hypothesis.Whataboutpubliclytradedcompaniesthatgoprivate,asis
oftenthecasewithmanagementorleveragedbuyouts?These
companiesarealsomakingatrade-off,but theyaretrading
offmorecontrolforlessliquidity.Inmakingthis trade-off,
though,notethatmostofthese“goingprivate”transactions
aredonewithaneyeongoingpublicagaininthenearfuture.
Thus,theilliquidity hereisforalimitedperiodand should
havea lowercost thanthepermanentilliquidityassociated
with being a private business.
Portfolio Management
If illiquidity represents a drag on value, investors haveto
examine its consequences when choosing investments and
developing trading strategies as well as when evaluating
portfolio performance. Consider the consequences for
investmentchoicesfirst.If,astheevidenceseemstoindicate,
lessliquidstocksgeneratehigherexpectedreturnsovertime
to compensate for illiquidity, investors with long time
horizonswillbeabletogenerateexcessreturnsbydirecting
theirmoneytowardtheseinvestments.Thehigherreturnsof
theseinvestmentswillmorethancoverthecostofilliquidity
fortheseinvestors.Themagnitudeoftheexcessreturnswill
dependontherelativenumbers ofinvestors with longand
short time horizons in themarkets, with the returns being
largest when long-term investors are scarce. In contrast,
investors with shorter time horizons should focus their
portfoliosmoreonmoreliquidinvestments.Generalizing,we
would expect investment strategies that combine high