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Corporate
Corporate governance and stock governance
liquidity: evidence from a and stock
liquidity
speculative market
Pallab Kumar Biswas
Department of Accountancy and Finance, University of Otago,
Dunedin, New Zealand Received 9 January 2019
Revised 21 June 2019
23 August 2019
1 September 2019
Accepted 3 September 2019
Abstract
Purpose – Grounded in lemon market theory, this paper aims to examine the influence of corporate
governance (CG) on stock market liquidity in Bangladesh, where stock market manipulation because of
speculative trading is a common concern.
Design/methodology/approach – This study is based on a sample of 2,420 firm-year observations
covering all non-financial firms in Bangladesh from 1996 to 2011.
Findings – This study’s results show a significant relationship between governance and liquidity within
firms over time. In particular, within firms, when governance quality increases, liquidity significantly
improves. For instance, a rise in the governance quality by one standard deviation decreases the illiquidity
ratio by 55.97%. The results are unlikely to be confounded by endogeneity.
Practical implications – The results have important policy implications for security regulators,
investors, traders and managers. The results support the current regulatory trend of strengthening CG
practices in the listed firms in Bangladesh.
Originality/value – This study contributes to the understanding of the role of effective firm-level CG on
stock liquidity in the context of an emerging country. Consistent with prior research mostly conducted in the
advanced economies, it provides further empirical support that higher CG quality reduces the information
asymmetry problem and enhances stock liquidity even in a speculative market.
Keywords Corporate governance, Bangladesh, Stock liquidity, Stock market speculation
Paper type Research paper

1. Introduction
Improvement in corporate governance quality (CGQ) often leads to better protection of
minority shareholders’ interests from possible expropriation by insiders and to increased
corporate transparency and better monitoring and control (Mallin, 2002). In the stock
market, increased corporate transparency reduces the adverse selection problem arising
from information asymmetry between informed and uninformed traders. In turn, the cost of
transacting in the company’s stock is reduced and stock liquidity improves. Consistent with
this notion, a growing literature documents a positive relationship between CGQ and stock
liquidity (Ali et al., 2016; Chen et al., 2007; Chung et al., 2010; Prommin et al., 2014). As
countries differ in terms of institutional characteristics (Bhuiyan and Biswas, 2007), whether
the results from the prior literature can be generalized to Bangladesh, a country with
different institutional characteristics, remains an open question and this study fills the void.

Accounting Research Journal

The author would like to thank two anonymous reviewers, Ellie Chapple (the editor), and Muhammad © Emerald Publishing Limited
1030-9616
Jahangir Ali (associate editor) for their constructive comments and suggestions. DOI 10.1108/ARJ-01-2019-0005
ARJ As an emerging market, Bangladesh represents an interesting research setting for a number
of reasons. First, dominance of family ownership, heavy reliance of bank loans to finance
capital needs, less sophisticated capital market and lack of stringent corporate governance (CG)
regulations are some of the common characteristics the Bangladesh capital market shares with
other emerging markets such as China, Thailand and Malaysia, where similar studies have
been conducted (Foo and Zain, 2010; Prommin et al., 2014; Tang and Wang, 2011). Therefore,
this study allows us to examine the extent to which previous research findings can be
generalized in a country with similar institutional features. However, emerging countries are
not homogenous and Bangladesh is no exception. For example, unlike other economies
where stock market performance reflects a country’s economic growth, the correlation between
the economic growth of the country and the movement of the stock market index is hardly
observed in Bangladesh (Roy, 2018). Ahmed (2016) notes that stock market investment in
Bangladesh is mostly ruled by day-traders. With an average holding period of a minimum of
three days, these active traders focus more on share price gain rather than regular dividend
earning. Consequently, the Bangladesh stock market is considered a highly speculative place
for investment. To maximize speculative gain, wealthy and politically connected investors
often form syndicates and devise many strategies and undertake various measures, often
violating the securities regulations in Bangladesh and, therefore, stock price manipulation is
quite common (Roy, 2018). Because of high information asymmetry between the traders and
because of a lack of knowledge of stock market operations, small investors often tend to make
their investment decisions based on rumors and gossips (Fardaus, 2015). Although CG is
generally considered to be an important mechanism to alleviate such information asymmetry,
the CG reforms in Bangladesh, like many other emerging countries, are based on an Anglo-
American shareholder model and therefore may not be applicable to the agency environment in
Bangladesh (Mueller, 2006; Siddiqui, 2010). Consequently, findings in other countries may not
be generalizable to Bangladesh, making it imperative to examine the role of governance on
stock liquidity in Bangladesh.
Using a sample of 2,420 firm-year observations from 1996 to 2011, we find CGQ and
stock liquidity to be positively associated in Bangladesh. The association is both
statistically significant and economically meaningful. For instance, pooled ordinary least-
squares (OLS) regression results indicate that a one-standard-deviation increase in CGQ is
associated with an estimated decrease of 55.97 per cent in the Amihud’s (2002) illiquidity
measure. We also observe a statistically significant positive association when stock liquidity
is measured using liquidity ratio (LR) and stock turnover ratio (TR). The findings are robust
to other proxies of liquidity, sub-sample analysis, individual governance categories and
alternative estimation methods to deal with endogeneity.
Our study makes several contributes to the literature. First, it contributes to the limited
literature in the emerging markets. A number of prior studies examine how corporate
policies and outcomes in emerging markets are different from those in developed nations.
This paper offers empirical evidence on the role of CG on stock liquidity in a highly
speculative market in Bangladesh. Second, while prior studies on CGQ and liquidity often
suffer from either a small cross-section or short-time series, our study uses an extensive data
set covering all the listed non-financial companies and uses a 16-year panel data set (1996-
2011). Finally, unlike prior studies that focus on individual components of CG, our study
provides evidence on how stock market liquidity is related to a comprehensive measure of
CG that covers multiple dimensions of CG, such as financial transparency and disclosure,
board structure and process and auditing.
The remainder of this paper is structured as follows. Section 2 discusses the institutional
characteristics of Bangladesh. Section 3 presents an overview of the existing literature and
development of the study’s hypothesis. Section 4 discusses the data and research methods, Corporate
including the models used to test the hypothesis. Section 5 deals with data analysis and is governance
followed by robustness checks in Section 6. Section 7 concludes the paper.
and stock
2. Institutional environment in Bangladesh
liquidity
The Bangladesh stock market started its operation as the East Pakistan Stock Exchange
Association Limited on 28 April 1954 with formal trading commencing in 1956. Despite its
63-year-old history, the number of listed companies stands at 311 as of December 2018.
Although the stock market offers a range of benefits of listing, the capital market is hardly
considered to be the primary means of raising capital in Bangladesh because of cheap bank
financing, required disclosure of information, costs and necessary formalities for listing,
retaining family control, and so on (Ahmed, 1998; BEI, 2003). Consequently, the Bangladesh
stock market suffers from a lack of supply of good-quality stock. The relatively small size of
the capital market, along with high information asymmetry among traders, lack of effective
securities regulation and poor enforcement allows a group of wealthy and politically
connected company officials and individuals to manipulate the stock market. This group of
individuals is often termed as “gamblers” or “syndicates” who use the capital market like a
casino (Ahmed, 2018)[1]. Different informal estimates suggest that the syndicate activities
constitute at least 30 per cent of the total daily turnover (Ahmed, 2018). These syndicates
tend to act together to artificially increase the prices of some stocks – especially the small-
capital and junk ones – resulting in sharp gains in consecutive sessions mainly based on
speculations (Uddin, 2018). Small daily retailers, with limited knowledge of stock market
operations, are often driven by such momentum because of a lower interest rate on bank
deposits and other limited investment opportunities, so they invest in such junk stocks
(Springer, 2014)[2]. Unfortunately, the security regulators and exchanges are often found to
formulate policies and regulations favoring these syndicates, which results in an “artificial
demand driven market.” Ahmed (2018) notes that “perhaps the bourse and to some extent the
regulators also do not want that gambling on the bourse be weeded out completely. They find
life of stock trading in it.”
As a result of a lack of supply of good-quality stocks, high information asymmetry and
market manipulation by syndicates, the Bangladesh capital market is considered to be
extremely inefficient and is driven more by speculation than fundamentals (Ahmed, 2016;
Springer, 2014). Therefore, it is not surprising that the stock market has witnessed two crashes
within a span of just 15 years. The first stock market crash took place in 1996, which
enormously eroded investors’ confidence[3]. Consequently, a lack of investors’ (local as well as
foreign) confidence in the operation and regulation of the capital market in Bangladesh,
exacerbated by weak regulatory enforcement, poor CG practices and the slow development of
capital market infrastructure are the main reasons cited for its relatively undeveloped capital
market in comparison with its counterparts in the South Asian region (Du, 2006; Farooque
et al., 2007; The Daily Star, 2004). To improve the situation, various reform programs, including
CG reform, have been undertaken in Bangladesh over the past two decades including the
introduction of CG Guidelines in 2006. Despite the CG reform, the Bangladesh stock market
could not escape its second stock market crash in 2010. According to the probe committee
report, some 60 individuals, many associated with the ruling and other major political parties,
including top officials at the Bangladesh Securities and Exchange Commission (BSEC), made
fortunes through stock market manipulation at the expense of thousands of retail investors
(Byron and Rahman, 2011). In such an environment, the role of CG in enhancing transparency
and improving stock liquidity is even more crucial than it is in other emerging and developed
ARJ countries, and therefore this study investigates the governance-liquidity nexus for
Bangladeshi-listed firms.

3. Literature review and hypothesis development

Dating back at least to Menger (1892), an accepted idea in economics is that any object that can
serve as a medium of exchange is likely to have or ought to have certain desirable
characteristics: portability, storability, divisibility and recognizability (Lester et al., 2011). The
issue of recognizability is also relevant to the stock market where uncertainty surrounding the
intrinsic value of a security is the norm, not the exception. Uncertainty remains even in
the most efficient capital market as the value of a security depends on the predictability of
future returns. Consequently, the higher the level of uncertainty surrounding the security’s
future prospects, the lower will be the recognizability by prospective security buyers and, all
else equal, the less liquid the security will be. In the accounting and finance literature, this is
commonly associated with the “lemons” problem (Akerlof, 1970).
According to the lemons problem in the context of stock market, when security buyers
cannot distinguish “good” securities (that are likely to generate higher positive cash flows in
the future) from “bad” securities because of information asymmetry, sellers of bad securities
will claim their securities are as valuable as the good ones (Akerlof, 1970). Realizing the
possibility that the sellers might trade on their information advantage, security buyers will
act to protect their interests from adverse selection costs, such as by broadening the spreads
of the affected stocks to compensate for potential losses arising from trading in these
securities by informed traders (Bauwens and Giot, 2001; Chen et al., 2007). These activities
will adversely affect the liquidity of the good stocks.
Timely dissemination of unbiased information is one way to alleviate the lemons
problem. Theoretical studies by Diamond and Verrecchia (1991) and Kim and Verrecchia
(1994) suggest that enhanced disclosure can reduce information asymmetry among
informed and uninformed investors. Therefore, “for firms with high levels of disclosure,
investors can be relatively confident that any stock transactions occur at the ‘fair’ price,
increasing liquidity in the firm’s stock” (Healy and Palepu, 2001).
Consistent with Chung et al. (2010), we argue that CG affects stock market liquidity as
effective governance decreases information asymmetry between security traders. CG
achieves this objective by improving the quality of corporate disclosure in a timely fashion
or improving the ability of shareholders to discern the quality of management and the true
value of the firm. To examine this notion, a number of studies have examined the influence
of cross-sectional differences in CGQ on their stock market liquidity. Using the
Transparency and Disclosure rankings of Standard and Poor’s (S&P) as the proxy for
governance quality, Chen et al. (2007) find that S&P 500 firms with better governance
quality enjoy higher stock market liquidity in terms of effective spread and quoted half-
spread, relative to others. Chung et al. (2010) and Jain et al. (2011) also document similar
findings in the US setting. Outside the USA, Bar-Yosef and Prencipe (2013), Karmani et al.
(2015) and Ali et al. (2016) conduct similar studies in Italy, France and Australia,
respectively, and document a positive association between CGQ and stock liquidity.
In the context of emerging countries, Tang and Wang (2011) and Lei et al. (2013) report a
statistically significant positive association between governance and stock liquidity in
China. Similar positive findings are also reported in the context of Thailand (Prommin et al.,
2014), Malaysia (Al-Jaifi et al., 2017; Foo and Zain, 2010) and Tunisia (Loukil and Ouidad,
2010). As these studies are mostly based on a limited sample size and short-term time-series
data, the findings may not be generalizable to the different Bangladeshi context. As
mentioned in Section 2, because of a number of institutional characteristics, Bangladesh is a
distinctive venue to investigate this relation. In terms of CG reforms, the BSEC issued the Corporate
CG Guidelines in January 2006 on a “comply-or-explain” basis following the Anglo-Saxon governance
model of CG. Uddin and Choudhury (2008) and Siddiqui (2010) cast doubt on the
applicability of such Western-styled governance models to traditional societies in
and stock
Bangladesh and encourage further research on CG issues in Bangladesh. It is, therefore, liquidity
timely to examine the impact of CG on stock market liquidity in Bangladesh.
In the capital market, as discussed in Section 2, politically connected syndicates often tend
to influence stock liquidity by artificially increasing the prices of some stocks – especially the
small-capital and junk ones with comparatively weaker governance structure. We take the
position that if the syndicates are solely responsible for stock market liquidity, firms with
relatively weaker governance should enjoy higher liquidity and we should observe a negative
association between governance and liquidity. However, if governance improves stock liquidity
for better-governed firms and at the same time market syndicates play their role to improve
stock liquidity of ill-governed firms, there should be no association between governance and
liquidity in Bangladesh. Given the mixed findings with regards to the effect of governance
reform on firm-level outcomes, and the stock market anomalies because of the presence of
market syndicates, the efficacy of CG in alleviating information asymmetry among informed
and uninformed traders and thereby enhancing stock liquidity is therefore doubtful. This
provides the context of the study and we test this using the following null hypothesis:

H1. There is no association between the quality of a firm’s governance and its stock
market liquidity in Bangladesh.

4. Data and methodology

4.1 Sample and data
We start with an initial sample of 3,714 firm-year observations representing all the listed firms
on the Dhaka Stock Exchange (DSE) from the period 1996-2011[4]. The sample period is
important, as it includes the BSEC CG Guidelines of 2006 and the stock market crash of 2010.
Consistent with prior literature on CG and stock liquidity (Chung et al., 2010; Ali et al., 2017),
financial companies (banks, non-banking financial institutions and insurance companies) are
excluded because of their unique financial, operating and regulatory characteristics. Missing
regression variables reduce the sample further by 363, leaving us with a panel data set
containing a total of 2,420 firm-year observations (220 unique firms). The yearly and industry
distribution of the sample observations are provided in Table I. The yearly distribution of the
sample in Panel A shows that the number of firm-year observations range between 114 (1996)
and 171 (2003). In terms of industry distribution (Panel B), the textile, food and allied products
and pharmaceuticals industries have the most observations, accounting for 22.11, 18.22 and
14.59 per cent of the total observations, respectively. Data required for calculating liquidity
were obtained from the DSE. The governance and firm-level financial data are hand-collected
from corporate annual reports and the quarterly BSEC publications.

4.2 Measuring stock market liquidity

Given the paucity of realized transaction cost data for Bangladesh and other emerging
countries (for example, Bekaert et al., 2007; Jun et al., 2003; Lesmond, 2005), three liquidity
proxies are used in this study: Amihud’s (2002) illiquidity ratio, LR and stock TR. These
liquidity proxies are justified as they are the most accessible measures in an emerging
market such as Bangladesh, and they capture the essence of stock market liquidity. For
example, Amihud’s (2002) illiquidity ratio captures the price movement associated with
ARJ Year Observations (%) Observations Year Observations (%) Observations

Panel A: Yearly distribution

1996 114 4.71 2004 168 6.94
1997 135 5.58 2005 164 6.78
1998 147 6.07 2006 162 6.69
1999 154 6.36 2007 160 6.61
2000 156 6.45 2008 159 6.57
2001 157 6.49 2009 135 5.58
2002 170 7.02 2010 133 5.50
2003 171 7.07 2011 135 5.58
Panel B: Industry distribution
Industry Observations (%) Observations
Cement and ceramic 161 6.65
Engineering 325 13.43
Food and allied products 441 18.22
Pharmaceuticals and chemicals 353 14.59
Processing (jute and paper) 139 5.74
Service 91 3.76
Textile 535 22.11
Tannery 115 4.75
Table I. Fuel 97 4.01
Sample distribution Miscellaneous 163 6.74
by year and industry Total 2,420 100

trading volume or the price impact of the order flow (Chai et al., 2010). Intuitively, the
illiquidity ratio can be interpreted as the daily stock price response associated with the value
of shares traded, which is consistent with the Kyle’s (1985) concept of liquidity (commonly
known as price impact or Kyle’s l ). The illiquidity ratio is calculated as follows:
1 XDiy  
ILLIQiy ¼ jRid j=VOLDidy (1)
Diy d¼1

where ILLIQiy is Amihud’s illiquidity ratio for stock i in year y, |Rid | is the absolute return
on stock i (in percentage) on day d, VOLDidy is the Taka (Bangladesh currency) trading
volume for firm i on day d of year y and Diy is the number of days in which the shares are
traded during the year ending on the balance sheet date.
The LR, also known as the Amivest measure of stock liquidity, captures the extent to
which trading volume is associated with one unit change in share price. In other words, this
measure is based on the idea that markets characterized by resiliency, breadth and depth are
more liquid and are better able to absorb a large trading volume without a substantial price
change (Kluger and Stephan, 1997). Hence, a higher LR implies higher depth or market
liquidity. Following Amihud et al. (1997), LR is measured as follows:
XDiy
VOLidy
LRiy ¼ Xd¼1
Diy
(2)
jR j
d¼1 idy

where VOLDidy is the daily trading volume for firm i on day d of year y, |Ridy is the absolute
return on stock i (in percentage) on day d of year y and Diy is the number of days in which the
shares are traded for firm i in year y.
 Stock TR captures trading frequency, that is, the number of times a share changes Corporate
ownership. Bartov and Bodnar (1996) report a significant association between trading governance
volume and information asymmetry. They argue that higher information asymmetry may
reduce trading volume, as uninformed traders may decrease their trades in these shares.
and stock
Consistent with Ahmed and Ali (2017), stock TR is measured as follows: liquidity
TRit ¼ VOLiy =NOSHiy (3)

where VOLiy is the total number of shares traded for firm i in year y and NOSHiy is the
number of shares outstanding for firm i in year y.
4.3 Measuring corporate governance quality
CGQ is measured using a firm-level CG score. It is an unweighted aggregate of scores on 45
CG elements within 3 categories that are likely to affect stock liquidity through their effects
on the firm’s financial and operational transparency:
 financial transparency and information disclosure (16 elements);
 board and management structure and process (17 elements); and
 auditing (12 elements) (Appendix).

Financial transparency and information disclosure includes elements relating to the

directors’ declaration on observance of CG Guidelines, related party transactions and other
disclosures. Board and management structure and process captures aspects of the
composition and functioning of the board of directors, board sub-committees, director and
managerial remuneration, and the establishment and effectiveness of the internal control
system. Auditing deals with questions on auditor’s appointment and rotation, the
boundaries of the auditor’s activities and the composition of audit fees.
Following prior studies (Botosan, 1997; Kelton and Yang, 2008; Khan et al., 2013), the
Cronbach’s coefficient alpha is calculated to assess the extent to which correlation among the
elements in each sub-index of the CGQ is attenuated because of random error (Cronbach, 1951).
The coefficient alpha for each sub-index exceeds 0.81, suggesting sufficient reliability to be
summed as an index (Nunnally, 1967). This also provides a good support that the set of
elements used to construct the individual sub-index capture the same underlying construct.
Following prior literature, CGQ is calculated by assigning one point for each governance
provision that is satisfied. Therefore, the CGQ score ranges from 0 to 45; the higher the score,
the better the firm’s governance quality.

4.4 Regression models

We use the following baseline model to test whether the quality of the firm’s governance has
any consequence for stock market liquidity. To reduce endogeneity concern, one-year lagged
firm-level governance and other control variables are used in the model.

LIQUIDITYi;t ¼ a þ b 1 CGQi;t1 þ b 2 LNMCAPi;t1 þ b 3 LEVi;t1 þ b 4 VOLATi;t1

þ b 5 PPETAi;t1 þ b 6 BMi;t1 þ b 7 LNPRICEi;t1

þ b 8 LNAGEi;t1 þ b 9 INSOWNi;t1 þ b 10 INSTOWNi;t1

þINDUSTRYi þ YEARt þ « i;t (4)

ARJ where LIQUIDITYi,t is the liquidity measure and CGQi,t is the CGQ measure for firm i in
period t  1. The definition and details of the variables in equation (4) are summarized in
Table II. To isolate the effect of CGQ on stock liquidity and to account for omitted variable
bias, a number of firm-level control variables have been included in our study following
prior literature (Ali et al., 2016; Charitou et al., 2018; Prommin et al., 2014; Prommin et al.,
2016): firm size, share price, return volatility, asset tangibility, firm age, leverage and insider
and institutional ownership. In addition, year and industry dummy variables are used to
account for any systematic year and industry effect on the dependent variable.
To test the association between CGQ and stock liquidity, pooled OLS with standard
errors clustered at the firm-level are used in this study.

5. Results
Data analysis in this study proceeds in two sub-sections: descriptive statistics are presented
first and multivariate analysis is contained in the next sub-section.

5.1 Descriptive statistics

Descriptive statistics for the variables used in equation (4) are presented in Table III. The
natural logarithm of the liquidity measures, market capitalization, stock price and firm age
are used to account for the high level of skewness in the distribution of the variables.
Amihud’s (2002) illiquidity measure, which ranges from 11.11 to 5.90, has mean and
median values of 1.12 and 0.83, respectively[5]. The means of the LR and stock TR are
11.63 and 1.46, respectively. The mean and median of CGQ are 19.51 and 14.00,
respectively, with a standard deviation of 10.15. On average, the sample firms carry 73
per cent in debt in their capital structure, suggesting that Bangladeshi firms mostly relied on

Acronym Measure Definition

ILLIQ Liquidity Natural logarithm of the daily ratio of absolute stock return to
trading volume in Bangladesh taka averaged over a number of
trading days in the financial year ending on the balance sheet date
LR Liquidity Natural logarithm of the sum of daily trading volume to the sum of
absolute stock return in a financial year ending on the balance
sheet date
TR Liquidity Natural logarithm of the sum of daily shares traded to the number
of shares outstanding in the financial year ending on the balance
sheet date
CGQ Governance quality Governance quality measure based on a checklist of governance
items
LNMCAP Firm size Natural log of total market capitalization on the balance sheet date
LEV Leverage Total liabilities divided by total assets
VOLAT Risk Weekly stock return volatility over the 52-week period ending on
the balance sheet date
BM Growth opportunities Book value of equity divided by market value of equity
PPETA Capital intensity Net property, plant and equipment to total assets
LNPRICE Price Natural log of stock price
INSOWN Insider ownership Proportion of ownership by insiders (directors and promoters)
INSTOWN Institutional ownership Proportion of ownership by institutions shareholder
Table II. LNAGE Age Natural log of one plus number of years since listing on the DSE
Definitions of INDUSTRY Industry effect Dummy variable indicating the firm’s industry
variables YEAR Year effect Dummy variable indicating the financial year
Variable N Mean SD Minimum Maximum
Corporate
governance
ILLIQ 2420 1.119 3.111 11.106 5.902 and stock
LR 2420 11.633 2.829 3.261 19.381
TR 2420 1.461 2.010 10.501 4.321 liquidity
CGQ 2420 19.514 10.15 4.000 43.000
LNMCAP 2420 18.924 2.014 14.047 26.528
LEV 2420 0.725 0.644 0.036 4.485
VOLAT 2420 0.07 0.034 0.008 0.186
PPETA 2420 0.467 0.233 0.009 0.948
LNPRICE 2420 4.585 1.579 0.105 9.468
LNAGE 2420 2.322 0.778 0.000 3.584
BM 2420 0.346 3.958 24.732 7.770
INSOWN 2420 0.431 0.190 0.000 0.976
INSTOWN 2420 0.162 0.134 0.000 0.716

Notes: This table presents descriptive statistics for variables used in this study. The variables are defined Table III.
in Table II Descriptive statistics

debt in financing. Return volatility and asset tangibility average 0.07 and 0.47, respectively.
The average log-transformed share price is 4.59. Finally, the insider and institutional
shareholders hold 43 and 16 per cent of the sample firm’s ownership, on average, supporting
the notion that most of the Bangladeshi firms have a concentrated ownership pattern.
Pearson’s product-moment correlations between the continuous variables are presented
in Table IV to validate data consistency as well as to highlight obvious instances of
significant multicollinearity. Table IV shows that the pair-wise correlations among the
liquidity variables are high, as expected. The correlations between CGQ and all liquidity
measures are positive and significant, except for ILLIQ, where the correlation is expected to
be negative by virtue of the definition of illiquidity. These results suggest that higher CGQ
improves liquidity. The correlations between the remaining continuous variables and the
liquidity are generally significant. Variance inflation factors (VIFs) of the independent
variables are computed to further check obvious instances of significant multicollinearity
(results untabulated). None of the VIFs exceeds 5.16 (the rule-of-thumb cut-off number is
considered to be 10 to identify instances of multicollinearity in the multiple regression
models), suggesting that multicollinearity is not a problem.

5.2 Multivariate analysis

Table V contains pooled OLS coefficient estimates for the regression of liquidity on CGQ
and other control variables. The dependent variables in Models 1, 2 and 3 are Amihud’s
(2002) illiquidity, LR and TR, respectively. The regression equation (4) is well-fitted with an
adjusted R2 of 78.7, 79.6 and 46.1 per cent for ILLIQ, LR and TR, respectively, with
statistically significant F-statistics. The coefficients of CGQ are significantly negative in
Model 1 and significantly positive in Models 2 and 3. After controlling for other factors,
higher CGQ appears to improve stock liquidity. In terms of economic significance, a one-
standard-deviation increase in CGQ leads to an estimated decrease of 0.444 in the log of the
Amihud’s (2002) illiquidity measure, which is equivalent to 55.97 per cent decreases in raw
terms. Similarly, an increase in CGQ by one standard deviation increases turnover and the
LR by 51.72 per cent and 4.55 per cent, respectively. Despite regulatory and institutional
differences, these results based on Bangladeshi firms are consistent with the prior body of
 ARJ

Table IV.
Correlation matrix
ILLIQ LR TR CGQ LNMCAP LEV VOLAT PPETA LNPRICE LNAGE BM INSOWN

LR 0.83***
TR 0.64*** 0.76***
CGQ 0.51*** 0.37*** 0.26***
LNMCAP 0.81*** 0.59*** 0.23*** 0.47***
LEV 0.31*** 0.22*** 0.19*** 0.10*** 0.31***
VOLAT 0.07*** 0.09*** 0.23*** 0.04* 0.02 0.06***
PPETA 0.16*** 0.05** 0.09*** 0.11*** 0.16*** 0.07*** 0.01
LNPRICE 0.30*** 0.21*** 0.10*** 0.27*** 0.49*** 0.20*** 0.03* 0.22***
LNAGE 0.17*** 0.33*** 0.27*** 0.23*** 0.04* 0.18*** 0.07*** 0.28*** 0.28***
BM 0.15*** 0.09*** 0.10*** 0.05** 0.16*** 0.79*** 0.07*** 0.02 0.13*** 0.11***
INSOWN 0.10*** 0.16*** 0.23*** 0.02 0.03 0.14*** 0.08*** 0.16*** 0.04* 0.09*** 0.10***
INSTOWN 0.06*** 0.05*** 0.04** 0.04** 0.03 0.03 0.06*** 0.01 0.05*** 0.12*** 0.08*** 0.21***

Notes: This table presents pair-wise Pearson correlation coefficients between the variables. *, ** and *** indicate significance at 0.1, 0.05 and 0.01, respectively.
The variables are defined in Table II
 First stage Second stage
ILLIQ LR TR GOVQ ILLIQ LR TR
(1) (2) (3) (4) (5) (6) (7)

REGC 16.567*** (31.84)

CGQ 0.049*** (4.06) 0.051*** (5.06) 0.060*** (5.57) 0.072*** (9.87) 0.052*** (7.74) 0.057*** (7.03)
LNMCAP 1.081*** (19.31) 1.034*** (24.42) 0.097** (2.16) 0.889*** (6.80) 1.069*** (19.99) 1.064*** (26.64) 0.110** (2.46)
LEV 0.611*** (4.22) 0.509*** (4.14) 0.698*** (4.45) 0.610(1.09) 0.597*** (4.13) 0.540*** (4.22) 0.710*** (4.27)
VOLAT 5.320*** (3.88) 7.944*** (6.41) 14.825*** (8.33) 6.298** (2.07) 2.134* (1.67) 4.941*** (4.18) 11.678*** (7.92)
PPETA 0.757** (2.26) 0.716** (2.37) 1.032*** (2.83) 0.423 (0.46) 0.664** (2.01) 0.632** (2.09) 0.942** (2.56)
LNPRICE 0.156** (2.49) 1.110*** (23.95) 0.326*** (6.39) 0.188 (1.22) 0.179*** (3.14) 1.127*** (26.80) 0.314*** (6.52)
LNAGE 0.803*** (6.53) 0.715*** (6.57) 0.768*** (6.23) 0.403* (1.65) 0.727*** (6.54) 0.652*** (6.50) 0.750*** (6.68)
BM 0.044** (2.36) 0.026 (1.47) 0.022 (0.87) 0.069 (0.75) 0.043** (2.23) 0.033* (1.73) 0.028 (1.02)
INSOWN 1.777*** (3.91) 1.999*** (5.41) 2.561*** (6.25) 3.202*** (2.73) 1.881*** (4.21) 2.085*** (5.64) 2.627*** (6.46)
INSTOWN 1.476*** (2.77) 0.694 (1.53) 0.303 (0.59) 2.815** (2.06) 1.590*** (2.96) 0.848* (1.86) 0.434 (0.84)
Year dummies Yes Yes Yes No No No No
Industry dummies Yes Yes Yes Yes Yes Yes Yes
Adjusted R2 0.787 0.796 0.461 0.796
F-statistic 111.895 121.889 31.130 191.90
Observations 2420 2420 2420 2420
Under-identification test 131.459***
Weak identification test 1013.809***

Notes: This table presents the results of OLS regressions (Models 1-3) and 2SLS regressions (Models 4-7) of stock liquidity on 1-year lagged CGQ and controls. The definition of
variables is provided in Table II. t-statistics are shown in parentheses and are calculated using robust standard errors that incorporate firm-level clustering. ***, ** and * indicate
significance at the 1%, 5% and 10% levels, respectively. Kleibergen–Paap rk statistics is used for weak identification test. Constant term is omitted for brevity

Table V.

liquidity
CGQ and stock
liquidity
and stock
Corporate
governance
ARJ literature that advocates the importance of governance in improving stock liquidity (Foo
and Zain, 2010; Prommin et al., 2014; Chung et al., 2010; Ali et al., 2016).
We find mixed results for the control variables with respect to their expected signs in
Table V. For example, volatility has a positive (negative) association with the liquidity
(illiquidity) ratios. This is in contrast with the inventory models of liquidity, which predict
that a more volatile stock has a greater bid-ask spread and, hence, lower stock market
liquidity. However, it is consistent with the information-based models of liquidity, which
predict that the relationship can be positive. Barclay and Warner (1993), for instance, show
that truly informed traders among a large group of uninformed liquidity traders tend to
camouflage their information by breaking up their orders into smaller units. Such activities
increase both the number of transactions, a measure of liquidity and the stock price, that is,
stock volatility. Uninformed traders may become overconfident because of illusions of
knowledge and control, and “. . .trade more actively and more speculatively than they
otherwise would, hold under-diversified portfolios, and have lower expected utilities, and
contribute to increased market volatility” (Barber and Odean, 2001). It is also consistent with
Prommin et al. (2016) and Ali et al. (2017).
Similar to Prommin et al. (2016), Ahmed and Ali (2017) and Ali et al. (2017), the tangible
assets ratio also has unexpected sign. A higher tangible assets ratio is expected to reduce
information asymmetry as tangible assets are easier to monitor and harder to
misappropriate. Although the negative coefficient on firm age, a proxy for risk in prior
literature, is not consistent with theoretical prediction and Australian evidences by Ahmed
and Ali (2017) and Ali et al. (2017), it is consistent with Prommin et al. (2016) who also report
a negative association between firm age and stock liquidity in Thailand.
In terms of ownership, higher insider ownership is found to decrease stock liquidity. This
is not unusual in Bangladesh for two reasons. First, as most of the Bangladeshi firms are
family controlled, higher insider ownership in such firms often creates a Type II agency
problem as a result of information asymmetry between controlling shareholders and
minority shareholders. Such information asymmetry leads to higher adverse selection cost,
resulting in lower stock liquidity. Second, insiders in Bangladesh are not allowed to freely
trade their shares without fulfilling some legal requirements of the BSEC and the DSE[6].
Because it is hard to tell whether the negative relationship is an outcome of information
asymmetry or artifactual, regression models are re-estimated with market capitalization
consisting of only the free-float shares. The results (untabulated) show that the coefficient of
insiders’ percentage ownership is negative and statistically significant at the 1 per cent level
when TR is used as the liquidity measure, suggesting a higher information asymmetry
problem in firms with higher insider ownership. In the context of Thailand, Prommin et al.
(2016) also report a statistically significant negative association between ownership
concentration and liquidity measures. Higher institutional ownership is found to be
associated with lower stock liquidity in Model 1, indicating perhaps that the role of
institutional investors in corporate monitoring is comparatively weak in Bangladesh.

6. Sensitivity analysis
We check the robustness of our results in several ways. For example, we estimate separate
regressions for each category of CGQ to understand which specific CGQ categories drive the
results. Untabulated results (available upon request) show that all the governance categories
are significantly associated with three dimensions of stock liquidity. These results suggest
that the relationship between CGQ and stock liquidity is unlikely to be driven by a few
governance categories.
 According to the probe committee (2011) report, an unusual jump in market activity at Corporate
the DSE started in October 2009 (monthly average index of 2,800 points) and continued until governance
December 2010 (monthly average index of 8,290 points). Such a steep rise could not be
sustained, and the bubble burst in January 2011. To examine the effect of CGQ during the
and stock
crisis period, a sub-sample analysis was conducted dividing the sample period into the liquidity
normal and unusual period. Untabulated results (available upon request) are qualitatively
similar to those of Table V. The statistically significant coefficient on CGQ at the 5 per cent
level or better in all models indicates that higher CGQ improves stock liquidity irrespective
of the study period chosen. These results confirm that the main results are not sensitive
during the stock market crisis in Bangladesh.
We also use two alternate proxies of stock liquidity as robustness check: number of
trades (natural logarithm of the average number of transactions in a financial year ending
on the balance sheet date) and trading volume (natural logarithm of the average value of
shares traded for a particular stock during the financial year ending on the balance sheet
date). The results (untabulated) indicate that CGQ is significantly and positively related
with these stock liquidity proxies.
Endogeneity is a common concern in governance research and this study is not an
exception. It is possible that CGQ and stock liquidity are endogenously determined; that is,
CGQ and stock liquidity may affect each other simultaneously (Li et al., 2012). In addition to
the lead-lag approach used in Table V, we used instrumental variable approach to deal with
endogeneity. Following Ali et al. (2016) and Prommin et al. (2014), regulation change dummy
(REGC) is included as an instrument which equals to 1 for the years after the introduction of
CG Guidelines 2006 and 0 otherwise. It is assumed that the firm-level CGQ should be higher
in the post-CG reforms period (2006-2011) than that of the pre-CG reforms period (1996-2005)
[7]. This suggests that CG reforms should be highly correlated with the firm-level CGQ.
However, there is no reason to assume that the CG reforms have a direct relationship with
firm-level stock liquidity. Therefore, a dummy variable indicating the CG reform should
function as a valid instrument.
Table V reports the results obtained using the instrumental variable in the framework of a
two-stage least squares (2SLS) regression. Model 4 presents the first-stage regression. The
coefficient of REGC positively and significantly explains firm-level CGQ. The instrument
also passes the relevance test, as the F-test statistic is significant at the 1 per cent level,
indicating that the IV is significant. F-statistic on the excluded instrument in the first-stage
regression of 1013.81 is much larger than the threshold value of 10, which indicates that the
instrument is not weak. As Staiger and Stock (1997) show, the weak instrument problem can
arise even when the first-stage t and F-tests are significant at conventional levels. Therefore,
a robust version of Stock and Yogo’s (2005) test statistics, known as Kleibergen–Paap rk
statistics, is used to see if the instrument is weak. As shown in Model 4, we reject the null
hypothesis that our instrument is weak in our specifications. Models 5-7 of Table V show the
second stage of the 2SLS regressions for each of the three dependent variables. The results
show that, similar to the OLS regressions, CGQ significantly and relatively predicts each of
the liquidity measures. These results confirm that higher CGQ enhances stock liquidity. The
2SLS model is also estimated using the generalized method of moments and the inferences
remain consistent.

7. Conclusions
Prior theoretical and empirical literature suggests that firms with higher-quality CG are
likely to have higher stock market liquidity because of their greater transparency and better
monitoring and control mechanisms. To the best of our knowledge, this is the first study to
ARJ examine the relationship in Bangladesh. Bangladesh provides an interesting setting for
several reasons, including relatively weak securities laws and their enforcement, less
stringent CG environment, its low litigation risk, its relatively weak market for corporate
control, high ownership concentration and stock market manipulation by syndicate(s) of
politically connected wealthy individuals.
Using a sample of 2,420 firm-year observations of all non-financial companies listed on
the DSE over a 16-year sample period from 1996 to 2011, we examine the relationship
between CG and three measures of firm liquidity. For this study, we construct the CGQ index
based on the CG practices of Bangladeshi firms and disclosure requirements. Our OLS
regressions show a statistically significant positive relationship between CGQ and liquidity.
The association survives even after controlling for an industry effect, a year effect, different
firm characteristics and after addressing endogeneity bias because of reverse causality. The
findings are also robust to alternative proxies of stock liquidity and sub-sample analysis.
The overall findings suggest that CGQ is an important determinant of stock liquidity.
Given that CGQ is instrumental to liquidity in Bangladesh, these findings have important
policy implications. The outcomes of our study are likely to help regulators to design
regulations that enhance stock market liquidity. Further, it may help investors and traders
to devise their share trading strategies by considering CG mechanisms of our study closely.
These findings also have managerial implications, as listed companies may improve their
stock liquidity by adopting best practices of CG that alleviate informational asymmetries
among share traders.

Notes
1. “Syndicate” is often used in the Bangladesh national press to identify these gamblers.
2. However, bank deposits tended to earn negative real interest because of a very high inflation rate
(Islam, 2017).
3. A review of stock market crash in 1996 is provided by Solaiman (2006).
4. We calculated liquidity measures from 1997 to 2012 to estimate the lead-lag regression equation.
5. Because the logarithm of the Amihud (2002) illiquidity measure is used, log (illiquidity) < 0 when
the value of the Amihud measure is less than one.
6. For example, no insider can buy or sell shares from 2 months before the end of its financial year
till the board of directors approves the financial accounts, which is equivalent to at least 6
months in a 12-month period.
7. The validity of the assumption that the CGQ is higher in the post-CG reforms period is checked
using the t-test which confirms that CGQ is indeed higher after the reforms.

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Appendix: Elements of governance quality score

Governance element
Financial transparency and information disclosure (Cronbach’s alpha = 0.81)
 Disclosure of the board of directors’ responsibilities regarding financial communication
 Disclosure of board’s statement on the fairness of financial statements
 Disclosure of board’s statement on maintenance of proper books of accounts
 Disclosure of board’s statement on the consistent adaptation of appropriate accounting
policies and estimates
 Disclosure of board’s statement on compliance with the Bangladesh Accounting
Standards and disclosure of any departure therefrom
 Disclosure of board’s statement on risk and uncertainty in using estimates and
judgments
ARJ  Disclosure of board’s statement on the company’s ability to continue as a going concern
 Disclosure of board’s statement on significant deviation from last year’s operating
results
 Disclosure of financial and operating results for the past three years
 The company has not received a qualified audit opinion in the current fiscal year
 The auditor signs the audit report within 120 days of the balance sheet date
 The annual general meeting takes place within nine months of the balance sheet date
 Disclosure on related party transactions
 Disclosure that no related party transaction took place during the year
 The company has disclosed information on dividend payment
 The securities regulator has not issued a warning or imposed a penalty for contravention
of any other securities law against any company or its directors in the current fiscal year

Board and management structure and process (Cronbach’s alpha = 0.89)

 Board size is between 5 and 12
 The chairperson and chief executive officer positions held by different individuals
 Board includes a minimum of one independent director
 Board includes at least one female director
 An audit committee has been established
 Non-executive/Independent director(s) sit on the audit committee
 Audit committee chair is a non-executive/independent director
 Audit committee includes an accounting or finance expert
 Audit committee meets at least twice during the year
 A compensation/remuneration committee has been established
 The company has appointed a chief financial officer (CFO)
 The company has appointed the head of internal audit
 The company has a CG Charter or Code of Best Practice
 The number of board meetings during the year is at least four
 Average board meeting attendance is 75 per cent or more during the year
 CFO and company secretary have attended the board meeting
 Declaration that the company’s internal control system is sound and effective

Auditing (Cronbach’s alpha = 0.88)

 The same firm is not working as the auditor of the firm for more than three consecutive
years
 Firm has not rotated its audit firm after one year of appointment
 Declaration that statutory auditor has not been engaged in appraisal or valuation
services or fairness opinions
 Declaration that statutory auditor has not been engaged in financial information systems
design and implementation
 Declaration that statutory auditor has not been engaged in bookkeeping/accounting
records/financial statements
  Declaration that statutory auditor has not been engaged in broker-dealer services Corporate
 Declaration that statutory auditor has not been engaged in actuarial services governance
 Declaration that statutory auditor has not been engaged in internal audit services and stock
 Declaration that statutory auditor has not been engaged in all other services as liquidity
determined by the audit committee
 The amount of audit fees paid to auditors is disclosed
 The company has not paid any non-audit fees to the auditors
 Amount of non-audit fees is less than audit fees

Corresponding author
Pallab Kumar Biswas can be contacted at: pallab.biswas@otago.ac.nz

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