When Do Listed Firms Pay for Market Making in Their Own Stock?: When Do Listed Firms Pay for Market Making in Their Own Stock

Financial Management (Impact Factor: 1.36). 05/2012; 44(2). DOI: 10.2139/ssrn.1944057


A recent innovation in equity markets is the introduction of market maker services paid for by the listed companies themselves. We investigate what motivates the issuing firms to pay a cost for improving the secondary market liquidity of their listed shares. We show that a contributing factor in this decision is the likelihood that the firm will interact with the capital markets in the near future. We show that the typical firm employing a DMM is more likely to need more capital, or plan to distribute cash through stock repurchases. It is also more likely to have exit by its insiders. We also show significant reductions in liquidity risk and cost of capital for firms that hire a market maker. Firms that prior to hiring a market maker have a high loading on a liquidity risk factor, experience a reduction in liquidity risk down to a level similar to that of the larger and more liquid stocks on the exchange.

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    • "Similarly, the impact of market-makers on liquidity cost is examined by several papers. Again, the evidence shows that liquidity cost decreased in, for example, the Italian market (Nimalendrau and Petrella, 2003), Stockholm market (Venkataraman and Waisburd, 2007), Dutch market (Menkveld and Wang, 2011), German market (Hengelbrock, 2012), and the Norwegian market (Skjeltorp and Odegaard, 2011). Finally, Jain (2003) examined the market structure of 51 stock exchanges and the results indicate that market-makers significantly decrease liquidity cost and this impact is more pronounced in less liquid emerging markets. "

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    ABSTRACT: We examine the effects of secondary market liquidity on firm value and the IPO decision. Competitive aftermarket liquidity provision is associated with reduced welfare and a discounted secondary market price that can dissuade IPOs. The competitive market fails in particular for firms or at times when uncertainty regarding fundamental value and asymmetric information are large in combination. In these cases, firm value and welfare are improved by a contract where the firm engages a Designated Market Maker (DMM) to enhance liquidity. Such contracts represent a market solution to a market imperfection, particularly for small, growth firms.This article is protected by copyright. All rights reserved
    No preview · Article · May 2015 · The Journal of Finance