The Market Reaction to Stock Splits

Authors

  • CHRISTOPHER G. LAMOUREUX,

  • PERCY POON

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    • Both authors from Department of Finance, College of Business Administration, Louisiana State University. Lamoureux gratefully acknowledges research support from LSU Council on Research and College of Business Administration. The authors also thank a referee and an associate editor of this Journal, as well as participants of LSU's workshop in finance—especially Mel Jameson, Bill Lane, Gary Sanger, Jim Wansley, and Bill Wilhelm—for useful comments. Thanks, too, to Shashi Dewan for assistance with the data. The authors are solely responsible for any errors.

ABSTRACT

In this paper, a model of market reaction to stock splits is presented and tested. We argue that the announcement of a split sets off the following chain of events. The market recognizes that, subsequent to the (reverse) split ex-day, the daily number of transactions along with the raw volume of shares traded will increase (decrease). This increase in volume results in an increase in the noisiness of the security's return process. The increase in noise raises the tax-option value of the stock, and it is this value that generates the announcement effect of stock splits. Empirical evidence using security returns, daily trading volume, and shareholder data strongly supports this theory. The evidence, in conjunction with this theory, also agrees with extant literature that splits result in decreased liquidity, but there is no evidence that this reduction in liquidity is priced.

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