Competing Theories of Stock Splits: An Analysis of Announcement and Implementation Effects

Abstract

By separating the stock split process into two distinct events, announcement and implementation, we test six competing split theories. Around split announcement, we examine signal communication and sophisticated trader theories, which focus on the reaction of public and large sophisticated traders. Around split implementation, we also study trading range, dealer promotion and broker promotion theories, which focus on the reactions of small traders, market makers and brokers. Finally, around both split announcement and implementation, we test trading inconvenience theory. Based on TAQ stock data from NYSE and Nasdaq, for split records between 1998 and 2005 we use changes in transaction activity, transaction costs, information asymmetry and analysts recommendation both after split announcement and implementation. We find that total transactions increase after both split announcement and implementation. Information asymmetry decreases significantly after split implementation, while it decreases only slightly after split announcement. The dollar effective spreads decrease and the percentage effective and realized spreads increase significantly after split implementation. Dealers' raw revenues increase after both split announcement and implementation and the number of analysts covering a stock increases after split implementation. By choice of split factor, a stock's price level is adjusted towards its industry median after implementation. We find evidence in support of the trading range, broker and dealer promotion theories. Our findings from short-period micro-structural analysis also support signal communication theory but trading inconvenience and sophisticated trader theories are not supported. In addition, the effects of dealer promotion were mitigated when the dollar tick size reduced from $1/16 to $0.01. The effects of broker promotion are positively related with the split factor. Finally, we examine transaction and competition conditions from non-primary markets after split implementation. Competition from non-primary markets does increase, while information asymmetry levels decrease by a larger amount in non-primary markets. These results indicate that the non-primary market does compete with its primary counterpart through cream-skimming practices.