When a Stock Becomes Easier to Trade, So Do Its Rivals

A rising tide of liquidity for one company also lifts its peers, boosting their stock prices and lowering trading costs

What happens when a stock suddenly becomes much easier to buy and sell? According to a study published in the Journal of Financial Markets, the benefits don’t stop at that one company and instead can ripple outward across an entire industry. 

Take Ford Motor Co.’s 1998 spinoff of its financial subsidiary, Associates First Capital Corp. Soon after the deal, trading volume in Associates’ stock jumped 262%. Notably, the stocks of Associates’ competitors also became easier to trade.

NYU’s Yakov Amihud, University at Buffalo’s Sahn-Wook Huh and UCLA Anderson’s Avanidhar Subrahmanyam tested this long-suspected but hard-to-prove phenomenon known as a “liquidity spillover.” They found that when one firm’s stock becomes more liquid (easier to trade), the stocks of related companies benefit, too. 

While the effect is less extreme for these related firms, their prices still rise, trading costs fall, and institutional investors become more interested in them. The researchers confirmed through a series of stress tests that this effect isn’t a fluke.

The challenge was finding a shock to a company’s liquidity that didn’t provide new fundamental information about the firm’s business or the overall business environment. And the researchers needed an event isolated to a specific company. They found it in two-step corporate spinoffs, which they call an “ideal laboratory for studying the impact of stock-specific (as opposed to economywide) shocks in liquidity on the liquidity (and other aspects) of related stocks.”

In a two-step spinoff, a parent company first sells a small stake — typically around 20% — of a subsidiary through an IPO. Months or years later, it distributes the remaining shares, usually at least 80%, to its own shareholders. Because this second step is announced well in advance and involves no new information about the company’s prospects, it creates a rare “clean” experiment. 

The only thing that changes on the effective date of the second step of the spinoff is how freely the stock can be traded. The spun-off subsidiary’s free float (the shares available for trading) surges, trading volume jumps, and liquidity improves. None of this happens because of any new news. It’s simply because millions more shares are now in the hands of investors who can buy and sell them. It’s like widening a two-lane road into a six-lane highway.

The Ripple Effect

Examining 68 two-step spinoffs between 1986 and 2017 from the Thompson Reuters’ SDC Platinum database, the researchers identified up to 100 related firms for each. The primary matching method found peers with similar stock price patterns to the spun-off firm, while a robustness check used the Hoberg and Phillips database to match by product similarity. 

Across six different liquidity measures, the story was the same: Liquidity improved for both the spun-off firm and its peers. The effect survived numerous checks, including controls for pre-spinoff liquidity trends, and adjustments for factors like company size, valuation and stock volatility.

The results consistently suggest that liquidity spills over from spun-off firms to their industry peers. Spun-off firms saw daily turnover nearly double and trading costs fall by more than 20%. Related firms experienced smaller, but definite, improvements, such as rising turnover, declining illiquidity measures and cumulative abnormal returns reaching 2%-5% over 60 days.

It would be reasonable to worry that the increase in trading of the spun-off stock would siphon activity away from competitors, creating a zero-sum reshuffling. The data suggests otherwise. Liquidity improved across the board, consistent with a rising tide rather than redistribution.

The mechanism appears to be cross-asset learning. As a spun-off stock becomes more liquid, its price becomes a clearer signal of value. Traders use that signal to better inform their decisions on related stocks, reducing uncertainty and trading costs. Supporting this, the researchers found that after the spinoff, related firms’ prices became harder to predict simply from their past returns. This is a classic sign that the market is processing information better.

Amihud, Huh and Subrahmanyam found, however, that not all firms benefit equally. Smaller, less liquid companies gained more from spillovers than their larger peers. Firms outside the S&P 500 saw greater improvements. This makes intuitive sense. When you’re already in a deep, liquid pool, adding more water doesn’t change much, but it only takes a modest inflow to make a noticeable difference in a shallow puddle.

The researchers’ results also show that institutional investors voted with their feet. Their ownership in spun-off firms jumped by more than 33 percentage points, and holdings in related firms increased by 2-5 percentage points. Since institutions are known to prefer liquid stocks, their rush to buy serves as a real-world confirmation of the liquidity improvements.

Crucially, the effects appear permanent. Unlike fire-sale spillovers where prices bounce back to earlier levels, the improvements documented by the researchers persist. The data found that the 60-day returns do not reverse, suggesting genuine, lasting changes in market quality rather than temporary noise.

The findings challenge the old assumption that capital is a finite resource that must be stolen from one company to feed another. They also convey a broader message for policymakers. Regulations affecting a set of firms’ liquidity, like short-selling constraints, disclosure rules and tick-size changes can have amplifying effects on related firms throughout an industry. Designing policy without accounting for these magnifying effects risks significantly underestimating the true impact of market regulation.