Stock liquidity effect on leverage: The role of debt security, financial constraint, and risk around the global financial crisis and Covid-19 pandemic

This study examines the heterogeneity of liquidity effect on leverage and the propensity of zero leverage. Using U.S. public firms from 1990 to 2021, we demonstrate that stock liquidity has significantly negative effects on total debt and secured debt while insignificant effects on unsecured debt. Firms with high stock liquidity reduce the portion of secured debt and increase unsecured debt amidst total leverage. The negative stock liquidity effect was alleviated following the 2007–2008 financial crisis (GFC) and was strengthened during the Covid-19 pandemic. We also provide the first evidence that stock liquidity increases the likelihood of zero leverage. Furthermore, we test potential economic channels and find that the liquidity effects on leverage are stronger for companies with more financial constraints and higher risk. Our results are robust to various measures of leverage and control for endogeneity. Overall, our results show that it is essential to consider the heterogeneity of corporate debt structure when analyzing the stock liquidity effect on leverage. Such effect varies significantly across different levels of debt security and the time periods around the GFC and the Covid health crisis.