Evading the Torpedo: Why Managers Avoid Stock Splits

Abstract

In this paper, we document a previously unknown cost of stock splits. We find that stock splits decrease firms’ ability to meet the market’s expected performance, resulting in lower earnings announcement returns post-stock split. In exploring the channels that drive this phenomenon, we find evidence that investors do not fully adjust their EPS expectations for stock splits and that managers use accruals earnings management to fill the gap of expected earnings. We show that this cost of stock splits significantly increases over time, which partially explains the puzzling decrease in the frequency of stock splits.

Keywords: Stock Splits, Earnings, Managerial Incentives, Returns, Non-proportional Thinking

JEL Classification: G30, G32, M21, M4