Liquidity and default risk in China: The double-edged role of state ownership

This study explores the impact of stock liquidity on firm default risk in China, focusing on the moderating role of state ownership. The empirical results confirm that enhanced liquidity decreases default risk; however, the interaction of state ownership weakens this relationship. Notably, state ownership strengthens the informational efficiency channel (the learning channel) but weakens the corporate governance channel, with the latter effect outweighing the former. The findings highlight the dual role of liquidity in reducing default risk and emphasize the implications of state ownership in shaping this relationship. These findings contribute to the literature on financial risk management and provide policy implications for improving corporate governance in state-controlled economies. • Enhanced liquidity decreases default risk, while the state ownership weakens this relationship. • State ownership plays a double-edged role in the liquidity–default risk nexus: it enhances the informational efficiency (learning) channel but weakens the corporate governance channel. • The weakening of governance mechanisms in SOEs offsets gains from improved informational efficiency, reducing the overall effectiveness of liquidity. • The corporate governance channel dominates the learning channel in China's institutional context, especially regarding Type II agency conflicts between controlling and minority shareholders. • Findings offer policy insights for emerging markets, showing that liquidity improvements must be paired with governance reforms in SOEs to effectively reduce default risk.