Stock Splits and the Trading Speed Improvement Hypothesis

47 Pages Posted: 25 Mar 2008

See all articles by Ji-Chai Lin

Ji-Chai Lin

Hong Kong PolyU

Wen Yu

University of St. Thomas - Opus College of Business

Ajai K. Singh

Department of Finance, University of Central Florida

Date Written: March 18, 2008

Abstract

Managers have repeatedly indicated in surveys that stock splits are intended to improve liquidity. However, previous studies using bid-ask spread and turnover as measures of liquidity find results to the contrary. This paper offers a new perspective on the issue. Stock splits can make buying shares more affordable to smaller investors, and split-induced higher trading costs can help attract more brokers to promote the stock and new limit-order traders to supply liquidity. Accordingly, we hypothesize that managers of firms facing order execution difficulty and lock-in risk have incentives to use stock splits to improve trading speed at the expense of higher trading costs. Consistent with the hypothesis, we find evidence that firms face trading difficulty prior to splits, and following the split trading speed improves. On average, about 72 percent of the split announcement returns could be attributed to the net benefit of anticipated trading speed improvement. Our findings indicate that trading difficulty is an important factor in firms' split decisions, and that the benefit of the improved trading speed outweighs the increased trading costs.

Keywords: Stock Splits, Liquidity, Trading Speed, Trading Costs

JEL Classification: G10, G30

Suggested Citation

Lin, Ji-Chai and Yu, Wen and Singh, Ajai K., Stock Splits and the Trading Speed Improvement Hypothesis (March 18, 2008). Available at SSRN: https://ssrn.com/abstract=1108392 or http://dx.doi.org/10.2139/ssrn.1108392

Ji-Chai Lin (Contact Author)

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

Wen Yu

University of St. Thomas - Opus College of Business ( email )

2115 Summit Avenue
St. Paul, MN 55105
United States
651-962-5428 (Phone)
651-962-5093 (Fax)

Ajai K. Singh

Department of Finance, University of Central Florida ( email )

College of Business Administration
12744 Pegasus Drive
Orlando, FL 32816
United States
407-823-0761 (Phone)
407-823-6676 (Fax)

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