Market Reaction to Stock Splits in Large and Liquid Stocks: Evidence from the Indian Stock Market

Abstract

This study investigates market reaction to stock splits using the standard event study methodology. The study uses stock splits in large and liquid stocks in the Indian markets during the years 2001 to 2012. According to a semi-strong form of efficient market hypothesis, any information content associated with corporate announcements must be reflected fully on announcement day itself resulting in an abnormal return. However, several studies report abnormal returns surrounding announcement as well as effective day of stock split, and many competing hypotheses are presented to explain such abnormal returns. Studies from India on market reaction to stock splits offer mixed results. (Gupta & Gupta, 2007) find significant abnormal returns surrounding ex-split day and not surrounding announcement day. (Joshipura, 2009) and (Ray, 2011) find abnormal returns surrounding announcement day. This study reports reaction to stock split in large and liquid stocks that are constituents of NIFTY or NIFTY Junior

INTRODUCTION

Stock split, as the term suggests, results in reduction in face value of a stock and thereby corresponding increase in number of outstanding shares. For instance, if a company goes for a 1:10 stock split, Rs. 10 face value stock is divided into 10 shares with face value of Re. 1 each. Nothing changes as far as total share capital of a company is concerned. Hence, when a company decides to split its stocks, price of the stock should come down in the proportion of the split ratio. If 1:10 stock split is announced, then stock price should th come down to 1/10 of the price before the split. This means that stock split is nothing but a mere cosmetic event and hence, announcement about the stock split does not contain any information to affect stock price in a way that leads to abnormal positive returns. Even if there is any information content associated with announcement of the stock split, it should be reflected in the form of abnormal returns on the announcement day itself. Having said that, several studies on developed markets report abnormal returns surrounding announcement and ex-days of stock split. Not many studies are available in the Indian context as stock split was not a feasible alternative for Indian companies earlier. Prior to 1999, SEBI allowed only two face values – rupees ten and rupees hundred. Some of the important studies examining the effect of stock split in the Indian context are by (Mishra, 2007), (Gupta & Gupta, 2007), (Joshipura, 2009), (Ray, 2011) and (Chakraborty, 2012). Evidences from these studies are mixed so far. (Chakraborty, 2012) reports that the abnormal positive returns effect associated with stock split is concentrated to small and illiquid stocks.

 
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