A Behavioral Signaling Explanation for Stock Splits

71 Pages Posted: 12 Mar 2020 Last revised: 29 Oct 2021

See all articles by Chenyu Cui

Chenyu Cui

University of International Business and Economics (UIBE) - Business School

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business

Jiaren Pang

Tsinghua University - School of Economics & Management

Deren Xie

Tsinghua University

Date Written: July 1, 2019

Abstract

We propose a behavioral signaling framework to explain the positive announcement effects of stock splits. (Retail) investors view stock splits as good news and are loss averse. Thus, a stock split can boost investors’ expectations of the firm’s growth potential and its stock price, but may also cause disproportionally larger price declines if the firm cannot meet investors’ high expectations. In equilibrium, only managers with favorable information use stock splits to signal. Empirical analyses of stock splits in China find supporting evidence for this explanation: (1) investors become more optimistic after stock splits; (2) higher split ratios are associated with stronger market reactions; (3) splitting firms have better future performance than non-splitting firms; and (4) they experience larger price declines when falling short of investors’ expectations. Institutional features of the Chinese stock market and additional analyses help rule out alternative explanations.

Keywords: Stock split, behavioral signaling, behavioral bias

JEL Classification: G35, G40, G41

Suggested Citation

Cui, Chenyu and Li, Frank Weikai and Pang, Jiaren and Xie, Deren, A Behavioral Signaling Explanation for Stock Splits (July 1, 2019). Available at SSRN: https://ssrn.com/abstract=3541201 or http://dx.doi.org/10.2139/ssrn.3541201

Chenyu Cui

University of International Business and Economics (UIBE) - Business School ( email )

Beijing
China

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

Jiaren Pang (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Deren Xie

Tsinghua University ( email )

Beijing, 100084
China

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