The equity market around the ex-split date: Evidence from India

Abstract

Theory suggests that stock-splits are cosmetic corporate events as they simply increase the number of outstanding shares and decrease the price of each outstanding share. Hence, there should be no significant effect on the value of the firm. However, empirical evidence suggests that the market generally reacts favourably to stock splits. The contradiction between theory, which expects no change in firm value consequent to stock splits, and the reality, with scores of evidence of significant market reaction, motivates the present study. The market response to stock splits is investigated with the dataset from an emerging country – India for the period from March 1999 to December 2008. Based on availability of data, analysis was possible for 234 splits. The result of the investigation is in line with the results of many other studies, which shows significantly positive returns on the day of split execution. • The regression analysis suggests that the positive reaction can be attributed to the small firm hypothesis and liquidity hypothesis. • The result for the post-split period is characterized by abnormally high negative returns which wipes out much more than the positive gain during the split execution. This seems to be mostly explained by the pre-split price increase, firm size, and size of transaction, suggesting that the firms which have experienced a high pre-split increase in price as well as the smaller firms are the ones which suffer the worst returns. • The significantly positive co-efficient for transaction size along with the observation that post-split average size of transaction has declined, implies trading intensity by small investors, who face severe negative performance in the post-split period. It is possible that small investors are lured to the market on split execution, while the informed players exit the same when the prices are at their peaks leaving the uninformed small investors with over-priced stocks, whose prices fall rapidly in the post-split period. These findings may have immense implications for the smaller investors in designing their trading strategies. There may also be implications for the market regulators in protecting the small investors.