Does stock liquidity affect the incentives to monitor? Evidence from corporate takeovers

We test whether stock liquidity affects acquirer returns through its hypothesized effect on institutional monitoring. We find that firms with lower stock liquidity have higher acquirer gains for takeovers of private targets, but not for takeovers of public targets. The negative relation between liquidity and acquirer gains is stronger when the threat of disciplinary trading (exit) by institutions is weaker and acquirers have higher agency costs. Acquirers of private targets with lower stock liquidity are more likely to withdraw deals and experience higher involuntary CEO turnover following value-destroying acquisitions. Our results support the hypothesis that stock liquidity weakens institutions' incentives to monitor management decisions, except in those cases where the disciplining effect of the threat of exit may be particularly high.