Evading the Torpedo: Why Managers Avoid Stock Splits
57 Pages Posted: 26 May 2021 Last revised: 14 Jun 2022
Date Written: June 13, 2022
In this paper, we document a previously unknown cost of stock splits: an increased likelihood of missing earnings targets and the associated capital market punishment. We show that both the likelihood of beating the market’s earnings expectations and earnings announcement returns decline post stock split, a result consistent with investors exhibiting non-proportional thinking (Shue and Townsend, 2021) around earnings expectations and firms having increasing difficulty of managing earnings to achieve the same EPS beat. This cost of stock splits is increasing significantly over time, as the market assigns a larger penalty on earnings underperformance. The increasing cost of stock splits, coupled with a modest decline in the benefits of stock splits, explains the decrease in the frequency of stock splits. Overall, our findings suggest that firms are concerned about the costs of splitting stocks and these increasing costs led to managers avoiding stock splits in recent years.
Keywords: Stock Splits, Earnings, Returns, Non-proportional Thinking
JEL Classification: G30, G32, M21, M4
Suggested Citation: Suggested Citation