Insider Trading and Stock Splits

Abstract

Stock splits have long presented a puzzle in finance. Unresolved questions are why do firms undertake them, and why do they offer abnormal returns both before and after the announcement date? Conventional explanations focus on making stocks more liquid and signaling firm prospects. However, abnormal returns, particularly before the announcement date, should raise strong suspicions of insider trading. We examined 718 split events in the emerging stock market of Vietnam and found evidence indicating illegal insider trading in stock splits by firms more vulnerable to inappropriate insider activity. Such firms were more likely to be split stocks. Their stocks also provided significantly higher returns when they did split than did other stocks. More telling, the abnormal returns prior to the split announcement for these stocks were extremely high, indeed higher than their post-announcement abnormal returns. This is precisely the pattern we would expect if insiders traded on their knowledge. Illegal insider trading, where it is possible to escape penalty, provides a new explanation for stock splits and their abnormal returns.