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Golden Research Thoughts

Volume 2, Issue. 3, Sept 2012

Available online at www.aygrt.net

ISSN:-2231-5063 ORIGINAL ARTICLE

GRT
Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

Veerta Tantia and Shinil Sebastian Assistant Professor,Christ University Bangalore

Abstract: The stock split occurs when firm adjusts par value of its stock. There is no value creation in this process. However, the stock split activities is something which is quite frequent an event . Therefore effects of stock splits are puzzling. In theory a stock split is merely an accounting change, which leaves investors no better or worse off than they were before the split. Yet stock splits are a relatively common occurrence. This implies that there must be some benefit, either real or perceived, that results from a firm splitting their stock. This paper employs event study to capture the impact of stock split on selected companies listed in NSE during the period 1999 - 2011. Using the standard event study methodology the analysis showed that return of sample companies has no statistically significant abnormal returns on the announcement & surrounding dates of stock split.

KEYWORDS : Stock Split, Event Study, Abnormal Returns INTRODUCTION A stock split is a reduction of the par value and increase in the number of shares proportionate to the split. Theoretically, shareholders receive no tangible benefit from a stock split, while there are some costs associated with it. Stock splits are at one level only cosmetic change, slicing the same pie into smaller pieces but not changing an investor's fractional ownership of the equity interest and votes in the company. Stock Splits essentially serve the purpose of rationalizing the share price and fundamentally have no relation with company's performance. Stock splits reduce the share price by split factor and increase the outstanding shares by the same. Hence, the performance of the stock in terms of price, liquidity and volume should have no relation with stock split. Yet it has been observed that there is deviation in the share price of the stock after the announcement of the split This means that if managers could increase share prices by splitting their firm's stock, both overvalued and undervalued firms will choose to split their shares, eliminating the informational content of the decision. Many investors in the stock market feel that splitting the shares of a stock for various reasons, in total they expect a greater total market value for the shares. This
Please cite this Article as :Veerta Tantia and Shinil Sebastian , Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies : Golden Research Thoughts (Sept ; 2012)

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

implies that there must be some benefit from a firm splitting its stock. The relationship between stock splits and stock prices has been a question for the investor. Stock split have been an important event to investor. This study will also enable the investor to know the company's intentions or motives behind declaring the split. Therefore effects of stock splits are puzzling. In theory a stock split is merely an accounting change, which leaves investors no better or worse off than they were before the split. Yet stock splits are a relatively common occurrence. This implies that there must be some benefit, either real or perceived, that results from a firm splitting their stock. LITERATURE REVIEW Grinblatt et al. (1984) found that in the period from 1967 to 1976, their sample of stocks realized excess returns during the three days surrounding stock split announcements. The findings of Desai and Jain (1997) pointed in the same direction, revealing that following stock splits, there was an excess return after a holding period of one year. After a holding period of three years, there was an even higher excess return. Ikenberry et al. (1996) examined two-for-one stock splits by NYSE and ASE firms from 1975 through to 1990 and obtained similar results. They observed excess returns in the first year after a stock split and better results in the first three years following a split. These gains were preceded by excess returns on the announcement date. The findings of positive excess returns were also found in other markets. In their paper, Wu and Chang (1997) found excess returns on the Hong Kong Stock Exchange. They examined 67 splits in the period from 1986 to 1992, and found the excess returns over the three days surrounding a split announcement amounted to an astounding 18.2%. Similar observations were made in the German Stock Exchange. Wulff (2002) reported excess returns during the four days following stock split announcements as well as during the four days after The effective date. Bechmann and Raaballe (2004) reported positive and significant announcement effect for Danish stock splits. They explained this announcement effect was a consequence of an increased payout of the splitting companies. In another paper, Elfakhani and Lung (2003) examined the situation in Canada and found. Conroy and Harris (1999) noted that a split brought its price back into the optimal price range. Managers were seen to engineer splits to return their company's share price to a particular level that was remarkably stable over time. Brennan and Copeland (1988) saw the essence of signaling argument as being that managers only split their stock if they were optimistic that the future share prices would increase, or at the very least not decrease. If a manager believed that the future share prices would decrease, they would not be willing to split the stock due to the increased cost of trading lower-priced stocks. McNichols and Dravid (1990) noted that managers did not explicitly intend for the split to be a positive signal about the future prospects of the firm, but the split could still convey information to the market. Institutional owners would then be in a better position to take advantage of the signal compared to individual owners, either because they traded much more than individuals and were not as wealth constrained or that they were more efficient at interpreting and processing the signal. Kalay et al. (2007) noted that stock splits were associated with abnormal returns. Dhar and Chhaochharia (2008) found that on the announcement date, there was positive average abnormal return which was very significant at 0.01% level. They also found that 77% of sample companies had positive mean return in respect of stock split. Kuse and Yamamoto (2004) came to the conclusion that stock markets did favorably evaluate announcements of stock splits. Korajczyk (1992) proposes that stock split can be used to reduce asymmetric information between executives and investors. When the executives get an opportunity to invest and finance it by raising new capital, the investors might misinterpret this event as due to overvaluation of stock price. The reaction of investors towards new issues is therefore negative. In order to reduce the information asymmetry, the executives split the stocks and follow it by new issues. Gupta and Kumar (2007) found that there was no announcement effect associated with stock split in India. Baker and Gallagher (1980) Lamoureux and Poon (1987) argued that the executives used the split to protect their interests from takeover threats. Larger investor base made it difficult for potential acquirers to control the company's stake. Byun and Rozeff (2003) examined the long-run consequences of 12747 stock splits covering the period from 1927 to 1996. In contrast to most previous papers, they found that stock splits were essentially value-neutral transactions. Leemakdej (2007) carried out a research of 100 splits in the Stock Exchange of Thailand and detected significantly negative returns in the 20 days before and 18 days after the

Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

effective date of the split, with the most significant returns clustered around the event date. A.K.Mishra (2007), taking the span of 1999-2005, concluded a negative effect on price and return of stock splits. OBJECTIVE OF THE STUDY: Studies by Grinblatt et al. (1984), Dhar and Chaoccharia (2008) and Fama et al. (1969) indicated that the markets reacted positively to stock split announcements. Other studies by Leemakdej (2007), Boehme (2001) and Goyonke et al. (2006) indicated that markets reacted negative to stock splits. Gupta and Kumar (2007) and Lakonishok and Lev (1987) in their studies on stock splits noted that markets did not react to stock split announcements. There then seemed to be no agreement on the effects of the stock split announcement. There has been no consensus on how markets generally reacted to stock splits. It is then not possible to generalize the kind of market reaction elicited by stock split to the Indian market, hence there existed a gap. The study sought to establish what happened in the National Stock Exchange when a company split its stock. The objective set for the study is To check the presence of any abnormal returns on or surrounding stock split announcement HYPOTHESIS TEST OF STOCK SPLIT: Null Hypothesis: Stock Split has no impact on Return of the Stock Alternate Hypothesis: Stock Split has impact on Return of the Stock DATA AND METHODOLOGY Stock splits have been prevalent in many markets for some decades now. However, they have gained popularity in the Indian stock market only since 1999. The sample includes companies that declared stock splits during the period June 1999 - December 2011 from nifty and nifty junior. The reason is, even though 'The Companies Act 1956' empowers a limited company to alter its share capital using stock splits, these events were not very common in the Indian stock market as the listed shares had a fixed face value of Rs.100 or Rs.10. The usage of stock splits increased after the Securities and Exchange Board of India (SEBI) vide circular no. SMDRP/POLICY /CIR- 16 /99 dated June 14, 1999 allowed companies to choose any face value for their equity share, provided it is not issued as a fraction of a rupee. The effect of this change, in terms of the number of stock splits announcements, was immediately visible in subsequent years. Therefore, the choice of this particular period seems appropriate as stock splits have gained in popularity in Indian markets only since 1999, post the SEBI circular. Data has been collected from Prowess(CMIE), a financial database of Indian companies, NSE website ,moneycontrol website ,journals, magazines etc.To study the impact of stock split on return our sample study consists of 22 companies where the stock split phenomenon is only relevant. To examine the market response to stock split announcement standard event study methodology is used. The ordinary least square (OLS) market model is applied for estimation of abnormal return on a specific stock. The event study procedures in this study are gathered from previous researches by Bowman (1983) and Brown &Warner (1980 & 1985). The event date is the date of announcement of stock split by the sample firm. It can be expressed as t 0.The event window in this study is 20 days before & 20 days after stock split. It can be expressed as -20 to +20. The estimation period for this study is 200 days before to 21 days before the event date. Abnormal returns are obtained by finding the difference between actual returns of the security j on day t & expected returns of security j on day t. The following is the formula for OLS market model to compute abnormal returns:ARjt = Rjt - ERjt Where ARjt = Abnormal return of security j on day t Rjt = Actual return on security j on day t ERjt = Expected return on security j on day t Actual return on security j in period t is computed as follows:-

Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

Where Pjt = Price of security j on day t Pjt-1 = Price of security j on day prior to day t Expected return on security j in period t is computed as follows:-

Where j = Risk free rate of return j= Relative riskiness of the security to market index Rmt= The rate of return on market index on the day t After computation of abnormal returns of all the securities the average abnormal returns (AARs) are computed during event period (-20 to +20). AARs are computed as follows:

Where AARt = Average of abnormal return for day t N = Number of securities in the sample The abnormal returns are aggregated trading day wise & then divided by number of securities. After this cumulative average abnormal return (CAARs) is computed. The formula for CAARt:

Where k = Number of event days before day t T test is used to determine the statistical significance of CAARt & AARt. For computation of t statistics the aggregate pre- event standard deviation of abnormal returns of all the securities is computed. Individual companys pre- event standard deviation i.e. (from -200 to -21) is computed & then aggregation is done. The formula for estimation of pre- event standard deviation of daily abnormal returns is as follows:

Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

AARpre = Average of abnormal return of security i estimated from pre- event measurement period Aggregate pre- event standard deviation is computed as follows:-

i, pre s is applied on AAR of each day. The t- test for AARs is as follows:-

For testing CAARs, The t test formula is:-

Where Nt = the absolute value of event day t plus 1 (e.g. for event day -20, the absolute value is 20 and Nt = 21) If the t-test statistic of AAR and CAAR is larger in absolute value than 2.08 or 2.83, the relevant abnormal return is statistically significant at 5% or 1% level respectively.

FINDINGS The main empirical results are shown in Table 1. It presents the results of the entire sample consisting of 22 stock split. For each of the 41 days in the experimental period it reports the Average daily Abnormal Returns (AARs) for days t-20 to t+20 along with the summary statistics for the tests of null hypothesis. The first column in the table gives the event day while the second gives the average abnormal returns on the event day. The t statistic values corresponding to the AARs are given in the third column. Column 4 shows Cumulative Average Abnormal Returns ( CAARs). Last column indicates t-stat for CAAR. Table 1: AAR ,CAAR and respective t-test for the sample study

DAYS -20 -19 -18 -17 -16 -15 -14 -13 -12 -11 -10

AAR -0.00642 -0.00413 -0.00074 -0.0018 -0.00778 -0.00087 0.008525 0.008252 0.003402 -0.00195 -0.00244

AAR t test -1.2202 -0.78533 -0.14036 -0.34233 -1.47822 -0.16505 1.619544 1.567661 0.646357 -0.37058 -0.46313

CAAR -0.00642 -0.01056 -0.0113 -0.0131 -0.02088 -0.02175 -0.01322 -0.00497 -0.00157 -0.00352 -0.00596

CAAR t test -0.0581 -0.10028 -0.11294 -0.13823 -0.23332 -0.25822 -0.16746 -0.06745 -0.02292 -0.05571 -0.10288

Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.003971 -0.01024 -0.00512 -0.00347 0.003905 -0.00177 0.003259 0.003337 -0.00154 0.005639 0.007286 -0.00119 -0.0071 0.000579 -0.00504 -0.00028 0.000531 -0.00408 0.006459 -0.00309 0.003582 -0.00434 0.000635 0.000703 0.004876 0.001958 0.002478 0.00184 -0.00276 0.000598

0.754413 -1.94571 -0.97257 -0.65992 0.741852 -0.33554 0.619194 0.633895 -0.29321 1.071296 1.384159 -0.22659 -1.34855 0.110075 -0.95743 -0.0531 0.100963 -0.77575 1.227107 -0.58615 0.680493 -0.82515 0.120582 0.133544 0.926365 0.371958 0.470699 0.349538 -0.52528 0.113693

-0.00199 -0.01223 -0.01735 -0.02082 -0.01692 -0.01868 -0.01542 -0.01209 -0.01363 -0.00799 -0.0007 -0.0019 -0.009 -0.00842 -0.01346 -0.01374 -0.0132 -0.01729 -0.01083 -0.01391 -0.01033 -0.01467 -0.01404 -0.01334 -0.00846 -0.0065 -0.00403 -0.00219 -0.00495 -0.00435

-0.03772 -0.2581 -0.41194 -0.56506 -0.5356 -0.70982 -0.73248 -0.76534 -1.29462 -1.51795 -0.06689 -0.12013 -0.42723 -0.31977 -0.42605 -0.37277 -0.31355 -0.36491 -0.20571 -0.24029 -0.16356 -0.21445 -0.19052 -0.16892 -0.10046 -0.07267 -0.04248 -0.02185 -0.04702 -0.03937

Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

From the above analysis we accept our null hypothesis that stock split has no significant impact on return of stock. The Table 1 and figure1 shows that for the 20 days before the announcement date there is no consistent pattern of abnormal returns of the companies engaging in stock split. The AARs before the announcement period (-20 to -1 day) are positive only for 7 days out of 20 days and are negative for 13 days. AAR are significant at 90 % level of is on day t-8. On the other days before announcement date there are no significant abnormal returns for the stockholders of the sample companies. On the announcement day there is an increase in abnormal return from -0.00154 to .005639.The AARs after the announcement date show no consistent pattern. After the announcement date for 8 days there were negative returns & for 12 days there were positive returns. AARs are not significant during this period but there is increase in positive abnormal return days compared to pre-announcement period.The pattern of CAAR is inconsistent during the study period. However on announcement day there was an increase in CAAR from -0.013 to 0.007. CONCLUSION This paper has examined the impact of stock split on firm's return. Data analyzed in this study consist of a sample of purely and solely public announcements of stock split by companies. Using the standard event study methodology the analysis showed that return of sample companies increased on the day of announcement of stock split by -0.00154 to .005639 .Our study accepts null hypothesis. The study reveals no statistically significant abnormal returns on the announcement & surrounding dates of stock split. Here it is observed that stock split may act as a signal of future capital increase to alleviate negative impact. REFERENCE
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Golden Research Thoughts Volume 2 Issue 3 Sept 2012

Impact of Stock Split on Return - An Empirical Study of Selected NSE Companies

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Golden Research Thoughts Volume 2 Issue 3 Sept 2012

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