Title: Social Norms and Corporate Peer Effects (Free)
Authors: Markku Kaustia and Ville Rantala (both of Aalto University)
Publisher: Social Science Research Network Working Paper
Date Published: March 2012
Peer pressure can have a powerful effect on corporate decision making, according to this paper, which finds that stock splits executed by companies competing in a given industry significantly increase the likelihood that industry counterparts will follow suit and divide their own stock — despite little evidence of a financial benefit, at least in the short term, from doing so.
In fact, stock splits undertaken by such peer companies had the same persuasive effect on a firm’s decision to do likewise as would a 40 to 50 percent increase in the price of its shares over the previous year, the kind of run-up that often precipitates a split. As further evidence that companies base their decisions on a close watch of their competitors, the authors found that firms were twice as likely to divide their stock within a year after their peers’ having reported positive returns from a split, compared with their reaction to reports of negative returns.
The authors see the effect of stock splits on peers as indicative of a broader interest in what competitors are doing and as a sign of “herding behavior.” The findings, they say, indicate that firms scrutinize both the choices that peers make more generally and the level of their achievement — and then emulate the winners. “A general implication of our results,” the authors write, “is that observations of peer firms can have a strong impact on corporate decision making, particularly in areas in which economic theory offers little guidance.” But even when outside advice is available, they conclude, “actions and outcomes of peer firms may constitute a more accessible source of information for corporate managers, and could thus have economically significant effects.”
In exploring how social norms affect corporate behavior, the authors decided to investigate peer effects on stock splits because they represent a “clean setting” for research. Splitting stock — increasing the number of publicly traded shares while decreasing their individual price so that the overall value remains the same — is a decision that almost any firm can make at any time, the authors note.
To isolate the effects of peer moves on a firm’s propensity to split stock, and to rule out any other motives, the authors controlled for variables related to stock price, market capitalization, past returns, and the company’s recent history of dividing its shares. The authors obtained stock price and split information, as well as firm data, from the Center for Research in Security Prices and the Compustat databases; analyst data came from the I/B/E/S Details database.
The sample consisted of all U.S.-based firms listed on the New York Stock Exchange (NYSE) with sufficient data available from 1983 through 2009. To measure the effect of peers, the authors assigned the firms to groups on the basis of their analyst following, in recognition of the fact that analysts typically monitor companies in a specific industry. By contrast, the conventional approach in this strand of research relies on industry classifications, such as those used in the Fama-French database, which are “too large to effectively identify the set of peers subject to managers’ constant attention,” the authors write.
To be included in a peer group, firms had to share a threshold number of analysts. During the survey period, an average of 1,501 firms and 2,076 analysts were in the sample each year, and more than two-thirds of the companies belonged to an analyst-based peer group. The average group size remained fairly constant across the time frame, from a high of 14 in 1987 to a low of 9.5 in 2002.
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.”
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.