Tick size increase and default risk of small-cap U.S. firms: Evidence from a natural experiment

Using the 2016 Tick Size Pilot Program (TSP 2016), we find that increased tick size significantly reduces the default probability of small-cap firms, a finding that is robust across alternative measures. TSP 2016 created mixed liquidity effects, namely reduced retail liquidity and improved institutional liquidity, yet both changes lower default risk. Trading slowdowns in reduced algorithmic trading also decrease default probability. Moreover, enhanced pricing efficiency, not the changes in institutional ownership, channels this effect, with short sellers anticipating risk shifts. Our results highlight how market microstructure influences the viability of small-cap firms and inform the development of capital market regulations.