A Behavioral Signaling Explanation for Stock Splits: Evidence from China

65 Pages Posted: 12 Mar 2020

See all articles by Chenyu Cui

Chenyu Cui

Tsinghua University - School of Economics & Management

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 explanation for the positive announcement effects of stock splits. There are two key behavioral ingredients in our model. First, (retail) investors have misconceptions about stock splits that make them view stock splits as good news. Second, investors are loss-averse and will be particularly disappointed if a splitting firm’s ex-post performance falls short of expectation. In a separating equilibrium, only managers with favorable private information use stock splits to signal. Using a comprehensive sample of stock splits in China over the period of 1998 to 2017, we find supporting evidence: (1) stock splits elicit positive announcement returns and a higher split ratio is associated with a stronger market reaction; (2) splitting firms have better future operating performance and more favorable analyst forecasts; (3) when future performance is poor, splitting firms experience larger price declines than non-splitting firms; (4) the announcement returns of stock splits are smaller for firms with higher institutional ownership and firms with higher pre-split prices.

Keywords: Stock split, behavioral signaling, nominal price illusion, loss aversion

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: Evidence from China (July 1, 2019). Available at SSRN: https://ssrn.com/abstract=3541201 or http://dx.doi.org/10.2139/ssrn.3541201

Chenyu Cui

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
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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