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This paper investigates how stock liquidity influences stock price crash risk using data from Chinese A-share listed companies between 2009 and 2018. Our findings show that enhanced liquidity increases stock price crash risk. This effect becomes more pronounced in firms with lower levels of information transparency and weaker external governance. Higher levels of management stock ownership and significant shareholdings by major shareholders also intensify the relationship between liquidity and the risk of stock price crashes. We explain for this phenomenon by short-termism and governance theory. Specifically, highly liquid stocks exert short-term pressure on management due to short-termism. To fulfil the profit expectations of short-term investors, management might resort to upward earnings management, and conceal bad news, thereby elevating the risk of stock price crashes. Governance theory argues that heightened liquidity facilitates the withdrawal of major shareholders upon bad news revelation, which intensifies the market reaction to bad news, potentially triggering additional stock selling and consequently elevating the risk of stock price crashes. Furthermore, our additional analysis reveals that liquidity exerts a more pronounced influence on crashes during a bull market than a bear market. And distinct property rights do not substantially alter the relationship between liquidity and crash risk.
Zhang et al. (Tue,) studied this question.
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