Investors like companies that take out loans

The new research, published in the journal International Review of Economics & Finance, offers large investors like superannuation funds insights to improve their trading strategies and efficiency.

When publicly listed companies take out loans they must disclose them to the market, and there are two schools of thought around whether this news is viewed positively or negatively by traders.

A negative read could be that the company might be in trouble and that's why a bank loan is required. So, some investors may stay away from shares in this company, reducing stock liquidity.

But the Deakin research found that the opposite is true, and when there is news of a new loan agreement, the liquidity of that company's shares actually goes up in the market.

Deakin Business School Associate Professor Harminder Singh said that was likely because potential buyers of this company's shares felt that a loan was effectively a bank giving its stamp of approval for that company, signalling it was a good investment.

"Traders may believe that if a lender decides to take the risk of investing its money in this company, then the lender must have done its due diligence and it means this is a safer company to invest in. That information gives people more confidence to trade in these stocks," Associate Professor Singh said.

Previous international studies have shown that loan agreements increase demand in that company's shares, but this is the first time researchers have looked at data to determine if loans also have an impact on stock liquidity.

Liquidity refers to how quickly shares can be bought or sold without substantially impacting the stock price. If there is a large difference between what buyers will buy and sell a certain stock for, that means the market is not very liquid. A smaller difference means greater liquidity.

Associate Professor Singh and colleagues from Curtin and RMIT universities examined 14 years of ASX data for their study. The results showed that following loan announcements, the spread of the trading stock price gets narrower in the company taking out the loan, improving their liquidity.

This narrowing effect was tighter for new loans rather than renewals (refinancing), with the premise that new loans signalled a vibrant and growing company.

Associate Professor Singh said greater stock liquidity was valuable in many ways, but primarily because it meant lower transaction costs for traders, benefitting everyone in the financial system.

"This is particularly important information for fund managers, institutional investors, hedge fund managers and superannuation investors. They know the acceptability of this company will go up and it will encourage them to trade in those stocks because they have more information," he said.

"These large investors are buying and selling shares every day, so the cost of transaction is important even if it changes a little. Ultimately this has a positive flow-on effect for all Australians with a superannuation account."

Associate Professor Singh said increased stock liquidity also increased the speed and confidence in trading.

"Investors have natural preference for liquid stocks. Individual as well as institutional investors always have more interest in liquid stocks as they find it easy to get in and easy to get out of liquid stocks," he said.

"The ASX wants the market liquid, so it benefits regulators too. And our study results are also reassuring for banks that the market is judging their investment decisions positively."

While the study looked at data from the ASX, Associate Professor Singh said he would expect to see similar results in other markets worldwide.