Strategic Corporate Finance: Applications in Valuation and Capital Structure

THE “LIQUIDITY DISCOUNT”

The liquidity discount may be evaluated from the relative market premiums or discounts—based on trading multiples versus the Global Industry Classification Standards (GICS) sub-industry median—with stock price premiums and discounts arrayed as a function of stock liquidity, using multiple measures of absolute and relative liquidity, including ADTV, float, ADTV/float, ADTV/outstanding, and shares outstanding. We reject price-to-earnings (P/E) multiples because they are distorted by financial leverage and more data are lost due to negative numbers. We reject EV/sales and EV/capital multiples for their higher standard error and lower predictive power.

Depending on the measure, significant valuation discounts are observable starting from about the 1st through to the 25th percentile of stock liquidity. Results are much more reliable with ADTV and less significant (statistical significance under the Wilcoxon sign-rank test at the 95 percent confidence level) for shares outstanding or for ADTV/float.

The stock price liquidity discounts range from roughly 10 percent to 20 percent and increase with illiquidity.6 There is no premium for higher levels of liquidity though there are statistically insignificant premiums with larger floats.

The impact of liquidity goes far beyond the roughly 1,800 U.S. stocks that fall below our liquidity benchmarks. Markets outside the United States frequently exhibit considerably lower levels of stock liquidity and may face significant ...