Market Reactions to Stock Splits: Experimental Evidence

Abstract

Stock splits and reverse splits often result in short-term abnormal returns even though such split events do not change any fundamental factors affecting the valuation of a firm's stock. In this paper we report on an experiment designed to better understand market reactions to stock splits and reverse splits. In one treatment, 2 assets have increasing fundamental values, and one asset is subject to a 2-for-1 share split while the other asset is not. In a second treatment, the fundamental values of both assets are decreasing, and one asset is subject to a 1-for-2 reverse split while the other asset is not. We find that in both cases, share prices do not fully adjust to changes in fundamental values per share following a split announcement. We provide evidence that the incomplete adjustment of share prices to splits or reverse splits can be attributed to heterogeneity in traders' cognitive abilities.

Keywords: Stock splits, asset pricing, behavioral finance, cognitive reflection, experimental finance

JEL Classification: G02, G12, C91, C92