Economic and Market Conditions Influence Stock Splits

On average, stock splits are more likely to be announced during bull markets than bear markets. More splits also occur during expansionary periods than during recessionary periods.

Though stock splits should have no impact on a company’s value, they often have had a positive immediate impact on the price of the underlying stock. Shares of companies splitting their stock experience short-term excess returns of 3% over a two-day period surrounding the announcement during bull markets. The excess return is even higher for the smallest 20% of stock-splitting firms: 5% during the two-day window in bull markets. During bear markets, the immediate excess returns are smaller: 2% and 3%, respectively.

The association between stock split announcements and higher short-term returns has been previously documented. The common explanation for the pattern is signaling: Corporations use stock splits to signal positive prospects for future earnings. This theory would explain why investors react favorably to split announcements even though a stock split does not change each shareholder’s ownership interest nor does it alter the financial or economic outlook for the company.

What has not been previously studied are the roles that market and economic conditions play in the decision by companies to announce a stock split. Researchers at universities in Australia and New Zealand analyzed more than 17,000 stocks splits announced by U.S. companies between 1926 and 2012. Stock splits became popular after the 1960s when the higher returns associated with splits was noticed more.

On average, stock splits are more likely to be announced during bull markets (an average of 20 per month) than in bear markets (13 per month). During the 20-year period of 1980–2000, there were nearly double the number of splits when the stock market was rising than when it was falling.

An even more stark difference exists during different economic conditions. Expansionary periods saw 16,105 split announcements, while only 1,450 splits were announced during recessionary periods. Almost 9,000 splits were announced during the 1982–1990 and 1991–2001 economic expansions.

The study’s authors say companies split shares following good earnings performance and then consider taking advantage of increasing investor sentiment in positive market conditions. Though the immediate returns are higher in expansions than in recessions, the two-week, post-announcement excess return is 0.5% higher during recessions. This is because the signaling effect of stock splits is stronger during contracting economic periods.

Source: “Real Determinants of Stock Split Announcements,” May Hu, Chi-Chur Chao, Chris Malone and Martin Young, International Review of Economics and Finance accepted manuscript.