Reduction of the Illiquidity Discount in Practice: For Listed, Scandinavian Companies

Abstract

This paper examines how Scandinavian exchange traded stocks can reduce their illiquidity discount in practice. Firstly, this is done by understanding why liquidity is relevant when valuating companies and also how liquidity can be measured for listed stocks. Hereafter, this paper studies what relevant effects an initiation of Commissioned Research can have on the listed stock. This paper also analyzes relevant differences between stocks that use Liquidity Provider and stocks that doesn’t use Liquidity Provider. The investigation in this paper is relevant because of the sizable increase in investment alternatives and also number of listed stocks, which makes poor liquidity a problem for a bigger part of the listed stocks. The scope of this paper is seen through the positivistic and deductive scientific philosophy enhancing a higher degree of generalizations by passive observations of causal relationships, though the relative high share of Swedish and unregulated stocks in this papers data, complicates a high degree of generalization across all listed shares in all Scandinavian countries. Additionally, the relatively short measurement periods from 2018-2022 for Commissioned Research and 2021-2022 for Liquidity Provider problematizes the generalizations in periods without the historically low interest rates and high liquidity provided by the national banks around the globe. The literature study finds an inverse relation between the required rate of return and degree of liquidity in an investment. This underlines that companies can lower their liquidity discount by increasing the liquidity in their listed stock. Overall, the analysis of the Commissioned Research’s effect on the listed stock’s shows a significant increase in the depth of liquidity on the initiation date. This is the result of a significant increase in the trading volume that is relatively larger than the also significant increase in the stock’s absolute change in value. However, the analysis also finds that shortly after initiation the liquidity returns to the previous level as before initiation. Lastly the analysis finds an average, positive return of 3,30% on the day of initiation, indicating that the published analysis attracts some kind of attention from the stock market. The analysis of the difference between stocks using and not using Liquidity Provider shows that the larger, regulated companies cannot pay to get a bid-ask spread that equals the spread of regulated companies that are not using the Liquidity Provider which are on average even larger and more liquid. Lastly, the analysis finds that the bidask spreads for unregulated companies using and not using Liquidity Provider are equally the same in times with stable returns on the stock markets. More interestingly the analysis uncovers that in times with negative stock market returns, the users of Liquidity Provider on unregulated markets experience a relatively smaller increase in their bid-ask spread than companies not using the Liquidity Provider. The analysis confirms the theory of ‘flight to liquidity’ by showing how the return of unregulated stocks that does not use Liquidity Provider suffers from a considerably more negative return compared to the stocks using Liquidity Provider in the measurement period where the stock markets as a whole experience lower liquidity and negative returns. This paper is anticipated to have relevance for the investors, the listed companies and also the providers of Commissioned Research and Liquidity Provider