Is Share Price Relevant?

Abstract

This study examines the cross-sectional effect of the nominal share price. We endeavor to understand two interesting puzzles associated with share price. First, the nominal share prices of the US stocks have remained remarkably constant since the Great Depression despite inflation. Second, there is no consensus about the motivations for firms to split their stocks, since financial theory suggests share price is independent of its value. The findings indicate that share price per se matters in cross-sectional asset pricing: stock return is inversely related to its nominal price. It is shown that a strategy of buying these penny stocks can generate a significant alpha even after considering the transaction costs. The abnormal returns of these penny stocks are robust in the presence of other firm characteristics such as size, book-to-market equity, earning/price ratio, liquidity and past returns; and are also not explained by the existing factors. These results also cast some light on the stock-split phenomenon. Intuitively, if firm managers know that low price would generate higher future returns, they are more likely to split their stocks on behalf of shareholders.

Keywords: Share Prices, Cross-Sectional Returns, Nominal Price Illusion

JEL Classification: G12, G14