Evading the Torpedo: Why Managers Avoid Stock Splits

Abstract

This paper documents a previously unrecognized yet significant cost of stock splits, reflected in lower earnings announcement returns (EAR) in the post-split period. We identify two primary channels underlying this phenomenon: lower earnings surprises (FE) and lower earnings response coefficients (ERC). First, firms that undergo stock splits tend to report lower earnings surprises post-split. Second, the quality of these earnings surprises declines as firms increasingly engage in earnings management to meet or beat earnings targets, resulting in a weaker market response. Collectively, our findings suggest a substantial and long-lasting cost to stock-splitting firms, as managers are unlikely to favor outcomes such as lower EAR, diminished FE, weakened ERC, and a heightened reliance on earnings management on an ongoing quarterly basis. Furthermore, the cost of stock splits has significantly increased over time, which partially explains the observed decline in their frequency.

Keywords: Stock Splits, Earnings, Returns

JEL Classification: G30, G32, M21, M4