Stock Splits as a Corporate Governance Device

35 Pages Posted: 22 Mar 2009

See all articles by C. Wei Li

C. Wei Li

University of Iowa

Ji-Chai Lin

Hong Kong PolyU

Date Written: March 18, 2009

Abstract

This paper models a stock split as a mechanism for inducing uninformed investors to pay brokers' analysts (through trading commissions) and informed investors (through trading losses) to monitor managers and make stock price more informative, which in turn creates a better investment environment with lower information risk for themselves. The increased price informativeness enhances the efficiency of equity-based managerial compensation, which motivates managers to put more efforts and consume less perks, but causing them to face higher stock price volatility. To overcome the adverse effect of price volatility on their expected utility, managers would do a stock split only when the firm has been doing well and the persistent component of earnings is sufficiently large. Thus, our model suggests that stock splits have economic benefits because they serve as a corporate governance device that invites market monitoring and keeps managers better motivated.

Keywords: stock split, signal, corporate governance, liquidity, managerial incentive, moral hazard

Suggested Citation

Li, C. Wei and Lin, Ji-Chai, Stock Splits as a Corporate Governance Device (March 18, 2009). Available at SSRN: https://ssrn.com/abstract=1364163 or http://dx.doi.org/10.2139/ssrn.1364163

C. Wei Li (Contact Author)

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business
Iowa City, IA 52242-1097
United States
319-335-0911 (Phone)
3193353690 (Fax)

Ji-Chai Lin

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

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