Do Stock Splits Improve Liquidity?

Abstract

The prior literature finds that stock splits worsen liquidity, as measured by percent effective spread, over a short horizon (60 to 180 days) after the split. We innovate by examining a long-horizon window after the split and by using new proxies for percent spread constructed from daily data. This allows us to track the liquidity of thousands of stock splits taking place from 1963 through 2003. We find that both the percent spread of NASDAQ split firms and the spread proxies of NYSE/AMEX split firms temporarily increase, but return to even with the control firms in 5 to 12 months. This provides a missing link supporting the signaling theory of splits. We also find that split firms are experiencing gains in liquidity at loner horizons. The percent spread of NASDAQ split firms becomes significantly lower than that of the control firms in 12 to 39 months. The spreads for NYSE/AMEX split firms become lower than the spreads for the control firms in 12 to 24 months. The NYSE/AMEX results are robust to three different liquidity proxies. This suggests a net benefit of splitting, which provides a missing link supporting both the trading range theory and the optimal tick size theory. All three theories could be true at the same time and our findings provide new evidence supporting all three theories.