The Importance Of Stock Splits Finance Essay

Stock Splits basically serve the intent of apologizing the portion monetary value and basically have no relation with company ‘s public presentation. Stock splits cut down the portion monetary value by split factor and increase the outstanding portions by the same. Hence, the public presentation of the stock in footings of monetary value, liquidness and volume should hold no relation with stock split. Yet it has been observed that there is divergence in the portion monetary value of the stock after the proclamation of the split and besides around the ex-date. The aim of this survey is to detect whether stock splits lead to an happening of unnatural returns around the ex day of the month and 60 yearss before and after the split. It will besides enable the investor to cognize the company ‘s purposes or motivations behind declaring the split.

Stock split is a comparatively recent corporate event in Indian fiscal market that intends to increase the “ affordability ” factor of the stock monetary value among little investors and therefore heighten the liquidness in the market. Though several surveies have been conducted in the developed economic systems, proving the impact of stock split on different market parametric quantities, there have been handful surveies on the topic in Indian market. One such survey by A.K.Mishra ( 2006 ) , taking the span of 1999-2005, concluded a negative consequence on monetary value and return of stock splits. This determination is contrary to the several other surveies in developed economic systems, such as US, Spain, Canada etc, where positive relation was established between stock splits and return.

In our empirical survey we have taken the survey of A.K.Mishra ( 2006 ) forward and extended our observation clip span from 2002 to 2009 when Indian capital market witnessed a robust growing, runing from bull market in 2005 – 2008 to bear market in late 2008 – early 2009 and a solid recovery thenceforth. As the old survey on stock split was concluded in 2006 when stock split was a recent phenomenon in Indian market, we believe that our new findings may aline with that of other bookmans who studied the developed market.

Finally, we targetted the companies listed on the NSE and narrowed our samples where the stock split phenomenon is relevant.

Hypothesis: Stock Split has no impact on the Price and Return of a stock

Independent Variables: Stock Splits, Split Factor

Dependent Variables: Monetary value and return/capital addition

Control Variables: Industry

The intent of the empirical survey is to prove whether stock split has any impact on the monetary value and return of a stock in the Indian capital market. In this attack, we have studied the plants of assorted surveies conducted in the yesteryear on stock splits. This has helped us in acquiring assorted positions in this issue and enable us to make an in depth literature reappraisal. There have been surveies which have been conducted in the U.S. context. Although markets react otherwise to stock splits in U.S. ( harmonizing to empirical findings ) , the methodological analysis of these instances has helped us make a instance survey on Indian companies and develop an effectual theory for our survey in the Indian context

There have been legion researches on the consequence of stock splits on different parametric quantities of capital markets. One such research paper advocates sing the three different market efficiencies ( weak signifier, semi-strong signifier, and strong signifier ) that the investor can do an above normal return by trusting on public information impounded in a stock split proclamation [ 1 ] . This survey agrees that harmonizing to the semi-strong signifier market efficiency, the stock split proclamation do impact the company stock monetary value. The sample of the companies under survey was taken from S & A ; P500 index.

The survey done by Desai, Jain ( 1997 ) elaborates more on long-term public presentation of common stock following stock splits proclamation and thence conclude that the capital market does n’t to the full reacts to the information conveyed in the stock split proclamation. Sing the neglected surveies of little houses, the paper examined steadfast portfolio of different sizes and more diverseness in footings of industries. Taking a big sample of stock information for a period of 1976 – 91, the research paper concluded that the market does non integrate the full consequence of the stock split proclamation in the month of proclamation [ 2 ] . Ikenberry and Ramnath ( 2002 ) , in their paper related to corporate intelligence events, excessively suggest the priorstudies that report unnatural return impetuss subsequent to splits do non look to be specious, nor a effect of misspecified benchmarks [ 17 ] . The findings supported that cardinal runing public presentation of a house is someway consequences the dividing procedure in the expectancy of addition of net incomes in future.

Few surveies went significantly far to capture the marks a stock split proclamation leave with the alteration of short involvement. One such survey was done by Padma, Vetsuypens ( 2002 ) that suggests that corporate events such as stock split that are alleged to convey favourable inside information should be associated with a diminution in short involvement. Positive stock returns at disconnected proclamations can non be distinguished between signaling and liquidness effects because stock splits are by and large believed to be liquidity heightening. Therefore, short involvement additions significantly for houses that experience post-split liquidness betterments [ 3 ] . On the other manus, one papers [ 4 ] that put up a strong negative relation between split-adjusted portion monetary value and subsequent returns was released by Brown, Pfeiffer ( 2007 ) . It states that split-adjusted portion monetary value as a deflator in misdirecting and should be dealt with cautiousness in empirical fiscal accounting and capital market research.

It is apparent that directors believe that stock split consequences in optimum trading monetary value of a stock that attract little investors and hence enhances liquidness. The research paper by Dennis, Strickland ( 2003 ) establishes a nexus between stock splits, liquidness and unnatural stock returns. Sing the function of institutional investors in the given stock scrip, the article concludes that the unnatural return is positive and negative related to the proportion of institutional ownership before the split [ 5 ] . Chiefly based on NYSE, NASDAQ and AMEX listed houses with the clip span of 1990 – 1993 calendar old ages, the research paper puts frontward some compelling decisions that suggests the immense impact of ownership of establishments on both liquidness and returns [ 23 ] .

In an all together different geographical location of Spanish stock market, the paper by Reboredo ( 2003 ) supports the much researched hypothesis in US markets that stock splits so cut down stock return and increase stock volatility and volume. Testing the several stock split hypotheses about optimum monetary value scope, Signaling, Tax-option, Tick size, and In yet another survey, Josef and Baruch ( 1987 ) attempted to reply the inquiry of why houses split their stocks or distribute stock dividends and why the market reacts favourably to these distributions [ 16 ] . The findings clearly distinguish between the effects of stock splits and stock dividends on fiscal markets and maintain the common decision that stock splits so restore the stock monetary value to its optimum trading scope.

For now it clear from about all the empirical studied that there has been an addition in volatility and volume during the proclamation and ex-date of a stock split [ 24, 25, 26, 27, 28, 29, 30 ] . Volatility to the extent of around 28 % around the ex-dates of the split has been found by Ohlson and Penman [ 31 ] .

The consequence on monetary value and return of the stock has conflicting empirical grounds in Indian and US context. The positive unnatural return of US stock splits has been experienced and reported by many empirical surveies. Few of the documents reported that rending houses experience about 3 % positive extra return after the proclamation of the stock splits [ 18 ] [ 19 ] [ 16 ] [ 21 ] [ 10 ] . US markets have seen a 7-8 % extra return in a twelvemonth after the proclamation of stock split [ 11 ] . Similarly for markets outdoors excessively, a important addition in return and monetary value has been found [ 12 ] [ 13 ] [ 14 ] . In India, empirical findings puts frontward that the consequence of stock split proclamation on monetary value is negative. Mishra ( 2007 ) explained the consequence of stock splits in fiscal markets by five possible hypotheses developed in the fiscal literature: Signaling, Trading scope, Liquidity betterment, Tax timing, and Tick size ( for optimum trading monetary value ) [ 21 ] [ 22 ] . He thereby concluded that directors ‘ determinations about realining the unit monetary value of their portions to a different monetary value scope have induced agents to revise their optimistic rating about equity and about future house public presentation [ 15 ] .

ownership construction, Reboredo concludes that stock splits have reduced the wealth of stockholders [ 6 ] .

The former fiscal documents have given accent to the importance of bid-ask spread and a diminution in relative spread post-split. The paradox of non-existence of liquidness diminution was offset by the theory of the addition of figure of trades. Huang and Weingartner ( 2000 ) countered the common belief and suggested that the spread-setting behaviour of the market does non alter after a split and signifiers that splits their portions outside into the preferable monetary value scope experience more marked effects [ 7 ] . These findings suggest that market participants regard stock split into an optimum monetary value scope as a nonevent. On the other manus, a research paper by Conroy, Harris, and Benet ( 1990 ) takes a base and to the full favors the stock splits in position of increased liquidness. It states that the per centum spreads addition after splits, stand foring a liquidness cost to investors [ 8 ] . The lessening in portion monetary value following splits is a consequence of increased spread and therefore accordingly be a portion account of addition in return variableness after splits.

A general mentality of the stock market is that stock split proclamation is attributed to increase in either future net incomes or near-term hard currency dividend. The market believes that the stock split is executed because a sudden addition in net incomes of the house may shoot-up the stock monetary value and accordingly makes it untradeable to little investors. Asquith, Healy and Palepu ( 1989 ) claims to govern out this misconception with their research paper and advocates that there is a negative relation between stock split proclamation and house ‘s future net incomes. [ 9 ]

Signing as expectancy is still caught up with the phenomenon of stock split. Future net incomes have therefore ever been associated non merely with the stock splits but besides with the split factor. Research paper by McNichols and Dravid ( 1990 ) supports the belief and advocates that the direction ‘s pick of split factor signals private information about future earning and that investors revise their beliefs about house value consequently [ 10 ] . It tells that the correlativity between split proclamations and split factor and net incomes prognosiss mistakes is significantly high.

Along with the split records ( company, X day of the month and Return on X day of the month ) , the associated industry and sector, Stock Beta and return on X day of the month was besides taken from the Prowess database.

Following filters were applied –

a ) The company should be listed on NSE.

B ) The Split ( X-Date ) should be after 2002.

degree Celsius ) Stock Price and Nifty Prices should be available on both the day of the months ( X date+60, X day of the month – 60 )

vitamin D ) Stock Beta should be available.

The concluding sample had 187 records ( interpreting to 748 informations points ) .

Table 1 study the twelvemonth and sector wise sum-up of the sample. Sector/Year

2002

2003

2004

2005

2006

2007

2008

2009

Entire

Cars

1

1

1

1

2

1

7

Electrical & A ; Electronicss

1

1

3

3

2

1

11

Financial Services

1

1

2

4

2

10

Cordial reception

1

3

2

6

Infrastructure

4

3

5

1

13

IT/ITES

5

1

1

2

6

15

Manufacturing

2

4

7

19

16

19

14

4

85

Other

1

3

3

2

3

3

15

Pharmaceuticals

4

2

8

3

1

2

1

21

Fabrics

2

2

4

Entire

2

10

11

41

35

35

35

18

187

As evident from the tabular array, fabricating sector witnessed the maximal figure of splits. And as reported earlier, station 2005/06, the figure of splits in the Indian Capital markets have increased significantly.

An analysis of the figure of splits by split ratio reveals that stocks with face value of 10 have witnessed more splits than those holding a face value of 5. Table 2 inside informations the split factor wise count of the same. Split Ratio

# of Splits

10:1

51

10:2

57

10:5

18

100:10

2

2:1

13

4:1

1

5:1

44

5:2

1

Entire

187

Statistical Trials

To look into the impact of stock split, we used the Student ‘s t-test to compare the average return observed over a 120 yearss period to the average return expected by the CAPM theory.

Actual Return was calculated based on the return on the stock monetary value. Expected return was calculated by utilizing the undermentioned expression. Expected Return = Nifty Return ( over the period ) * Stock ‘s Beta

The hypothesis –

H0 – Stock Split do non impact the returns on stock monetary values.

H1 – Abnormal returns are observed because of stock split.

Using the t-test, the P value found was.98 % .

Empirical Consequences

The P value observed was.98 % and hence it can be said with 99 % assurance that stock split do impact the return on stock. Besides every bit mentioned in the literature reappraisal, it is observed that the volumes around the ex-Date see a important rise.

However the exact consequence of stock split on returns is still unpredictable. While some sectors gave abnormally higher returns that the expected returns, it has been the antonym for the others. Furthermore, we could non happen any conclusive relation between split factor and unnatural return of the stock.

Decision

This survey has analyzed the market consequence of stock splits on stock monetary value and return around the split ex-dates for a sample of stock splits undertaken in the Indian market during 2002- 2009. Though finance theory predicts that stock splits have no consequence on the market behaviour around the proclamation, our survey has concluded that stock splits make a positive impact on stock ‘s return, as compared to index return, over the period of clip. This new determination is contrary to the survey done by Mishra in 2007 where he concluded that stock splits have reduced the wealth of stockholders.

The findings of this survey rely to a great extent on the premises of Capital Asset Pricing Model. However it is non ever true, stock returns do give unnatural returns as compared to those predicted by CAPM. Another restriction of the survey is the little sample size, even though the figure of stock splits in India has increased over the old ages, the figure is non sufficient to give a sector wise impact of stock splits.

Taking the findings provided by Mishra [ 15 ] frontward, it is apparent that stock split do consequence the return. But the exact consequence on the return can non be concluded with certainty.