Does Scale Strengthen Value Creation from Liquidity?Firm Size and the Conditional Liquidity: Value Nexus in Kenya
Abstract
This study investigates the influence of firm size on the relationship between liquidity and market valuation for firms listed on the Nairobi Securities Exchange in Kenya. The debate in corporate finance over the impact of firm liquidity on market valuation is unresolved, with research yielding mixed outcomes: some studies find a positive relationship, while others indicate a weak, negative, or context-dependent connection. By examining whether the scale of a firm amplifies or mitigates the value obtained from maintaining liquid assets, this research seeks to provide clarity on this unresolved issue. Using a 16-year balanced panel (2007–2022) of 51 firms listed on the NSE, with a total of 816 firm-year observations, the study operationalized firm liquidity using three metrics: short-term liquidity, asset convertibility, and new debt capacity, which were combined into a composite liquidity index. Firm size was measured through the natural logarithm of total assets and number of employees, resulting in a composite size index. Firm value was assessed using Tobin's Q. A battery of diagnostic tests confirmed the effectiveness of a robust, clustered fixed-effects estimator utilizing standardized interaction terms. The findings indicate that composite liquidity has a strong, positive, and significant direct effect on firm value (β = 0.962, p < 0.001). Furthermore, this relationship is significantly enhanced by firm size, with total assets exhibiting a coefficient of β = 0.038 (p < 0.001), the number of employees showing statistical significance (p = 0.003), and a composite size index registering β = 0.016 (p = 0.013). Larger firms are more effective in converting liquidity into value compared to smaller firms, aligning with Size Effect Theory and the concept of economies of scale in financial flexibility. This indicates that liquidity policy must be assessed in relation to firm size, highlighting important considerations for investors, corporate treasurers, and regulators, particularly in emerging markets. Keywords: Firm liquidity, firm size, firm value, panel fixed effects model.