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Published: August 31, 2012

 
 

The Peer Pressure Posed by Stock Splits

The annual number of splits varied sharply over time, however, ranging from 354 announcements in 1983 to four in 2009. On average, each year, 8 percent of NYSE firms split their stock, the authors found, while the corresponding percentage for firms with a peer group was almost 10 percent, meaning that firms sharing analyst-based and industry connections were slightly more likely to announce a split than those outside a group. However, firms with analyst-based peers accounted for a skyrocketing percentage of the total splits in the later years of the study, increasing from 34 percent in 1984 to 92 percent in 2008, a rise perhaps fueled by the ability to track news about competitors more closely.

One traditional explanation for splits is that they satisfy investors’ occasional demand for low-priced stocks, and this view suggests that “firms may believe they are making value adding decisions by following successful splitters,” the authors write.

But if that’s the motivation, decision makers may be disappointed, because the authors found scant financial benefit. Firms that followed successful peers had stock returns that were only 8 basis points higher than average immediately after the split, a statistically insignificant difference.

“Managers can interpret peer firms’ splits as evidence of the benefits of share price management,” the authors write, “and conclude that peer firms are splitting because their management sees that the lower nominal share price has a positive impact on firm value.” On the other hand, they say, “it is possible that firms overreact to observations about their peers’ actions and outcomes.”

Bottom Line:
Companies are more likely to divide their stock when peer firms have recently done so, and especially when their counterparts have experienced positive returns after the split. However, following the crowd provides little financial benefit to companies, and is primarily evidence of the powerful effects of peer pressure on corporate decision makers.

 
 
 
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