What is a Liquidity Event?

 Liquidity event refers to the merger, acquisition, sale, or purchase of a company. It also refers to the relationship whereby a company purchases the assets and assumes the debts of another company. In other words, the liquidity refers to a company obtaining liquid cash via a structural transaction.


How does a Liquidity Event Work?

 Liquidity can be used by the company seeking emergency cash to invest in other business or offset unknown externalities or financial risks. This makes the liquidity an important aspect that enable companies to seize opportunities. When the company or the shareholders have cash at their disposal, or can get access to finances easily, they are placed at a better position to seize the opportunity that comes around. Checkable accounts, cash, and savings accounts are some of the liquid assets for individuals and companies since they are readily available cash for any use. This kind of cash is important for equity investment or financing the ongoing business. 

Example of Liquidity Event 

Facebook company was founded by Mark Zuckerberg, other individual co-founders and the venture capital firms which are listed as the major shareholders of the company. The founding of Facebook was as a result of a liquidity event. The company began by raising $16 billion in the IPO and started as a publicly trading company with a valuation of $ 104 billion. By that time Mark Zuckerberg was the major shareholder owning 28.2 % of Facebook which worth approximately $29.3 billion as his liquid event. Thereafter, some of the companys such DST Global, and Accel partners joined Mark Zuckerberg to spread the cell and increase the bandwidth of Facebook through increased investment. Besides the commonly available liquid event are initial public offerings and direct acquisition by the major companies.

Academic Research on Liquidity Events

  • Liquidity risk in stock returns: An event-study perspective, Cao, C., & Petrasek, L. (2014). Journal of Banking & Finance45, 72-83. This article examines the factors that impacts the relative performance of stock in the event of liquidity crisis. The study discovered that the market risks that are evaluated by the market beta does not provide a profound result regarding the expected abnormal stock returns during the liquidity crisis. Alternatively, abnormal stock returns in the event of liquidity crises seems to be strongly negative with regard to liquidity risk. As such the co-movement measurement seems to provide the best measurement for the stock returns with market liquidity. The study also present that the ownership structure and the degree of the informational symmetry provides indispensable explanation of the abnormal stock return during the financial crisis. 
  • IPO as a Liquidity Event: How Accumulation Constraints Generate New Issue Underpricing, Booth, J. R., & Booth, L. C. This paper discusses the relationship between managerial incentives and audit fees in the mutual fund industry. this study discovered that the fees paid for the auditing services seems are higher when the managerial incentives regarding the financial reporting are poor. The result of this study suggested that the profession of auditing, to some extent recognize the adverse management incentives created by the contracting and company arrangements are reflected by the fees charged for the auditing services.  
  • Market, Trading at Low Levels? Reverse Mergers May Work, But Not for All: When a private company acquires a public shell, its a cheap liquidity event, Lacey, S. (2002). Investment Dealers Digest: IDD, 13-13.  This paper discusses the factors that motivates the use of a reverse merger (RM) instead of IPO to make a private company public and further evaluates the survival of RMs and IPOs in the aftermarket. According to the author, the private companies that uses the RM technique are younger, smaller and have poor ex ante performance on average than those using IPOs. Moreover, some of the private organizations that uses RMs, fail to meet the listing requirements as IPOs meet at least one requirement of the listing exchange. 
  • Liquidity events and the geographic distribution of entrepreneurial activity, Stuart, T. E., & Sorenson, O. (2003). Administrative Science Quarterly48(2), 175-201. This paper examines the effects of ecology of IPOs and merger acquisition particularly on how spatial distribution of the IPOS and acquisition impacts the founding rates of a specific location of the new companies. The study further explores whether relatively small spatial units in almost one geographical proximity exhibit new venture rates. It also examines whether the impacts of the effects of the IPOs depend on regional differences and the governing statutes in relation to the employees and the employers. 
  • Liquidity risk and the cross-section of hedge-fund returns, Sadka, R. (2010). Journal of Financial Economics98(1), 54-71.  This paper discusses the liquidity risks and the returns of the cross-section hedge funds. The paper presents that the measurement of the liquidity risks by the covariation of the fund returns with unpredicted variations in the aggregate liquidity provide profound determinant in the cross-section of hedge fund returns. The study revealed that finances that greatly load on liquidity risks out do low loading finances. 
  • The microstructure of the flash crash: Flow toxicity, liquidity crashes and the probability of informed trading, Easley, D., De Prado, M. L., & OHara, M. (2011). Journal of Portfolio Management37(2), 118-128. This paper examines the impacts and the microstructure of the flash crash. The author presents that the flash crash was caused by the new dynamics that exists in the contemporary market structure. The author also presents that role of the order toxicity in influencing the provision of the liquidity and its measurement. It further presents that the volume synchronized probability provides the best measurements for the order toxicity in the periods prior to the collapse. The study state that flash crash could be avoided had the providers of the liquidity remained at the market place.
  • Liquidity dynamics in an electronic open limit order book: An event study approach, Gomber, P., Schweickert, U., & Theissen, E. (2015). European Financial Management21(1), 52-78.  This paper analyses the dynamics of the liquidity in an electronic order book by using the Exchange Liquidity Measure (XLM) that measures the cost of a given size of the round-trip trade. The study used the methodology of the intraday event study to evaluate how liquidity shocks large transactions and Bloomberg ticker information impacts XLM. The study found out that, the resilience that occurs after a huge transaction is considerably high such that the liquidity quickly moves back to the normal level. The author also provide that large traders examines and times the period when the liquidity is not high. The author also revealed that the Bloomberg ticker information does not have significant effect of the liquidity.
  • Liquidity, bank runs and bailouts: spillover effects during the Northern Rock episode, Yorulmazer, T. (2008). This paper examines the spillover impacts during the episode of the Northern Rock. The author presents that the subsequent bailout announcement and the bank run created significant impacts in the banking system of UK. This is measured by the abnormal returns that were experienced on the stock prices of the banks. The study also shows that these effects were based on the rational responses of the investors to the news in the market regarding the liabilities of the banks.
  • Time-varying credit risk and liquidity premia in bond and CDS markets, Bhler, W., & Trapp, M. (2009). (No. 09-13). CFR working paper.  This paper examines the credit risks associated with varying time and liquidity premia in bonds. The study incorporated the used of CDS model to determine the impacts of risks on the liquidity risks. The author presents that the CDS liquidity considerably affects the liquid components and the bond credit risks. Besides developing the credit links, the paper also documented the relationship between the CDS markets and the bonds. It was therefore revealed that the liquidity in both the bond and CDS market decreases as the credit risks increases and the higher the liquidity in the bond market, the lower the liquidity in the CDS market. 
  • Is default event risk priced in corporate bonds?, Driessen, J. (2004). The Review of Financial Studies18(1), 165-195. This paper presents empirical analysis of the decomposition of the liquidity, default and tax factors that determines the expected corporate bond returns. The paper discovered the effects of liquidity, risk premia, and critical impacts of tax to the bind markets.
  • Measuring systemic risk-adjusted liquidity (SRL)A model approach, Jobst, A. A. (2014). Journal of Banking & Finance45, 270-287. This paper examines the use of Systematic Risk-adjusted Liquidity model in determining the liquidities that occurs in the market. The authors present that less focus has been put in place to comprehensively address the issue of externalities in especially in the liquidity market. In this regard, the author seeks to determine by using the SRL model the impacts. The model improves the price-based liquidity regulations by connecting the mismatch in the bank`s maturity that affects the financial stability and risks that exists in the liquidity market.

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