This paper investigates the relation between stock liquidity and firm performance. The study shows that firms with liquid stocks have better performance as measured by the firm market-to-book ratio. This result is robust to the inclusion of industry or firm fixed effects, a control for idiosyncratic risk, a control for endogenous liquidity using two-stage least squares, and the use of alternative measures of liquidity. To identify the causal effect of liquidity on firm performance, we study an exogenous shock to liquidity—the decimalization of stock trading—and show that the increase in liquidity around decimalization improves firm performance. The causes of liquidity's beneficial effect are investigated: Liquidity increases the information content of market prices and of performance-sensitive managerial compensation. Finally, momentum trading, analyst coverage, investor overreaction, and the effect of liquidity on discount rates or expected returns do not appear to drive the results.

Miller [1977. Risk, uncertainty, and divergence of opinion. Journal of Finance 32, 1151–1168] hypothesizes that prices of stocks subject to high differences of opinion and short-sales constraints are biased upward. We expect earnings announcements to reduce differences of opinion among investors, and consequently, these announcements should reduce overvaluation. Using five distinct proxies for differences of opinion, we find that high differences of opinion stocks earn significantly lower returns around earnings announcements than low differences of opinion stocks. In addition, the returns on high differences of opinion stocks are more negative within the subsample of stocks that are most difficult for investors to sell short. These results are robust when we control for the size effect and the market-to-book effect and when we examine alternative explanations such as financial leverage, earnings announcement premium, post-earnings announcement drift, return momentum, and potential biases in analysts’ forecasts. Also consistent with Miller's theory, we find that stocks subject to high differences of opinion and more binding short-sales constraints have a price run-up just prior to earnings announcements that is followed by an even larger decline after the announcements.