The effect of incomplete information and illiquidity on asset prices: Evidence from exchange listings

Gregory Bryant Kadlec, Purdue University

Abstract

Several studies have examined the behavior of common stock prices of over-the-counter (OTC) firms that obtained new listings on either the New York Stock Exchange (NYSE) or the American Stock Exchange (ASE). The results of these studies indicate that listing announcements are accompanied by an increase in share value of approximately six percent. While many authors have offered intuitive justification for this finding, their answer to the natural question of how listing increases share value remain, for the most part, unsupported by direct empirical evidence. The purpose of this study is to provide empirical support for a theoretically based explanation for the increase in share value which accompanies listing. More specifically, this study reports the results of a joint test of the "superior liquidity services" hypothesis motivated by the asset pricing model of Amihud and Mendelson (1986), and the "superior investor recognition" hypothesis motivated by the asset pricing model of Merton (1987). The sample includes a total of 270 OTC market firms that obtained listing on the NYSE during the period July 1980 through December 1989. This sample updates previous empirical work concerned with the value of exchange listing and allows for a test of the "superior liquidity services" and "superior investor recognition" hypotheses. The primary methodology employed is an event time study of listing announcement abnormal returns on a number of proxy variables for the asset pricing factors suggested by the theories of Amihud and Mendelson (1986) and Merton (1987). These proxies include: the change in the relative bid-ask spread from pre- to post-listing periods, the change in the number of shareholders from pre- to post-listing periods, and the relative market value and market model residual variance of the listing stock. Tests indicate that, on average, stocks earn abnormal returns of approximately five percent in response to the listing announcement and that listing is accompanied by lower bid-ask spreads and a greater number of shareholders. Regressions of listing announcement abnormal returns on proxy variables for the asset pricing factors of Amihud and Mendelson and Merton are consistent with the predictions of both "superior liquidity services" and the "superior investor recognition" hypothesis as explanations for the increase in share value that accompanies listing.

Degree

Ph.D.

Advisors

McConnell, Purdue University.

Subject Area

Finance

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