Stock splits: Earnings, returns and liquidity; Case analysis

Abstract

Stock split is a corporate action where the face value of the equity share of a company is reduced and proportionately the number of shares outstanding increases. For example, the share capital of a company consists of 100 equity shares of Rs. 100/- each. The company decides to reduce the paid up value of each share of the company to Rs.10/- then the number of shares outstanding would be increased proportionately to 1000 shares. Stock splits have been quite an interesting phenomenon in the field of finance. Asquith, Healy and Palepu (1989) find that stock splits usually happen after increase in stock prices and they bring positive stock price reaction after the announcement of stock splits. This positive reaction is not fully understood because stock splits do not affect the cash flows to the firm. Grinblatt, Masulis and Titman (1984) point out empirical findings that the stock prices react to cash dividend announcements and capital structure changes as these decisions affect the cash flows to the company. In contrast to these types of corporate actions is the announcement for stock splits. Stock splits do not change the capital structure of the company and it is merely an accounting adjustment. Stock splits are mere cosmetic accounting change with no direct cost and benefit. However, empirically they have observed that the wealth of the shareholder increase by about 3.30% in the two days around the stock split announcement date. This has been observed in a sample 244 stocks selected to avoid the effect other simultaneous news. As these split announcements do not involve any costs, it serves as a good choice to both overvalued and undervalued firms for stock prices adjustment.