Stock liquidity, cash flow sensitivity and the value of cash

Using a sample of U.S. public firms from 1990 to 2017, we find that firms with higher stock liquidity are associated with lower cash flow sensitivity of cash. An analysis of the market value of cash shows that each additional dollar of cash and investment in non-cash assets is worth significantly more in firms with high stock liquidity than in firms with low stock liquidity. Further analysis indicates that firms with high stock liquidity enjoy higher investment efficiency and invest more in capital expenditure and R & D. The reduction in cash flow sensitivity through improved stock liquidity is more pronounced when firms demonstrate lower financial constraint, information asymmetry and risk, and stronger corporate governance (i.e., fewer agency problems). Overall, these results suggest that stock liquidity reduces information asymmetry and the agency costs of free cash flow, thus contributing to value enhancing investments which improves company valuation.