The Effect of Stock Splits on Liquidity: Evidence from Shareholder Ownership Composition

Abstract

The traditional view of stock splits as cosmetic transactions that simply divide the same pie into more slices is inconsistent with the significant wealth effect associated with the announcement of a stock split. Streetlore attributes the price reaction to improved liquidity. The empirical evidence, however, suggests that there is no appreciable change in the trading volume of firms after a stock split. This is especially surprising given that Lamoureux and Poon (1987) among others report a substantial increase in the number of shareholders for splitting firms. This suggests that any increase in liquidity is potentially a function of the ownership structure of the firm. This paper examines the impact of firm ownership composition on liquidity changes following stock splits. Our analysis yields three main results. First, our analysis indicates that changes in liquidity, measured by volume of trade, are negatively related to the level of institutional ownership prior to the split. This indicates that firms with low institutional ownership prior to the split achieve the largest liquidity benefit following the split. Second, the largest post-split increase in institutional ownership occurs for firms that had low institutional ownership prior to the split. This result indicates that the large increases in trading volume for firms with low institutional ownership prior to the split is the result of increased institutional ownership following a split. Last, we find that the abnormal return following a split is negatively related to the level of institutional ownership prior to the split. This is consistent with the notion that the market rewards those firms that have the largest increase in liquidity following a split. These findings are important as they shed new light on the source of stock split announcement returns.

JEL Classification: G12, G14, G32