THE HIDDEN COSTS OF STOCK-MARKET LIQUIDITY

The seemingly unrelated problems of stock market liquidity and manager -stockholder contracting are closely intertwined. Active stockholders who reduce agency costs by providing internal monitoring also reduce s tock liquidity by creating information asymmetry problems. Conversely, stock liquidity discourages internal monitoring by reducing the costs of 'exit' of unhappy stockholders. The U.S. has exceptionally many ac tively-traded firms with widely-diffused stockholding because public p olicy has favored stock market liquidity over active investing. And, t he benefits of stock market liquidity must be weighed against the cost s of impaired corporate governance.