Stock splits have been for a long time a puzzling phenomenon that can bear particular consequences for stock’s liquidity as well as for a rate of return. The author performs an analysis of the stock splits accomplished within the time frame of 2000–2011 by companies listed on the New York Stock Exchange. The author seeks to identify whether the stock splits under consideration constitute any signal to existing and potential shareholders and whether the stock split can add value to shareholders’ wealth.
Author uses three methods to analyze the impact of stock splits on the rate of return for 629 stocks listed on the New York Stock Exchange, i.e. mean adjusted return method, market model method and market adjusted return method. The data used includes daily rates of return and the event window encompasses the time period of [40;+40], i.e. the interval from the 40th stock exchange session preceding the stock split to the 40th session after the stock split, as well as the first session after the stock split.
Author reports that in the wake of the stock split the volatility of abnormal returns declined under three methods employed by: 9.93%, 52.4%, and 47.8%, respectively. This fact points out benefits derived from splitting the shares, e.g. stabilization of the share price and consequently a change in stock’s risk–return profile. In turn, it can alter investors’ perception of a given stock.
Furthermore, author argues that shareholders’ gains as measured with cumulative abnormal rates of return, all 1–percent significant, reached within the event window outperformed pre–split benefits, i.e. achieved as a result of a buy–and–hold strategy within the time frame of [–40;–1] as well as those attained in the post–split era, i.e. in the interval [+1:+40], using the same strategy. Investors who pursued the first strategy averaged with the cumulative abnormal rates of returns for three methods used at the level of: 40.64%, 14.62%, and 39.24%, respectively. Therefore the stock split can be viewed as a value creation vehicle what is consistent with the theory of corporate finance.
On the other hand, these findings show that managers that expect an improvement in financial health of their companies decide to split the shares thus conveying information what, in turn, is congruent with the signaling hypothesis. Moreover, author observes a substantial increase in the stock price in the aftermath of the stock split what partially supports the hypothesis that managers try to shift the stock price to an optimal trading range. Nevertheless, an attempt to define the extent of the optimal range of the stock price goes beyond the scope of the article.
Wrocław University of Economics