We find that stock liquidity increases stock price crash risk. To identify the causal effect, we use
the decimalization of stock trading as an exogenous shock to liquidity. This effect is increasing
in a firm’s ownership by transient investors and nonblockholders. Liquid firms have a higher
likelihood of future bad earnings news releases, which are accompanied by greater selling by
transient investors, but not blockholders. Our results suggest that liquidity induces managers to
withhold bad news, fearing that its disclosure will lead to selling by transient investors.
Eventually, accumulated bad news is released all at once, causing a crash.