[10:22 26/12/2014 RFS-hhu070.tex] Page: 486 486–520 Liquidity and Shareholder Activism

Blockholders ’ incentives to intervene in corporate governance are weakened by free-rider problems and high costs of activism. Theory suggests activists may recoup expenses through informed trading of target firms ’ stock when stocks are liquid. We show that stock liquidity increases the probability of activism but does less so for potentially overvalued firms for which privately informed blockholders may have greater incentives to sell their stake than to intervene. We also document that activists accumulate more stocks in targets when stock is more liquid. We conclude that liquidity helps overcome the free-rider problem and induces activism via preactivism accumulation of target firms ’ shares. (JEL G14, G34) Through their voting rights, shareholders have the formal power to affect the governance of public companies. But shareholder activism is a rare event, a fact often attributed to its considerable costs.1 Election contests demonstrate how costs can be substantial. A shareholder seeking to replace existing board members in a proxy contest must run a public campaign, hire legal expertise, and pay for producing and distributing his own slate of directors to the company’s other shareholders.2 Even if the overall value added exceeds the costs, a large shareholder’s incentives to monitor and intervene are hampered by free-ridin