The Differences between Stock Splits and Stock Dividends - Evidence from Denmark

Abstract

This paper investigates and compares stock dividends and stock splits on the Copenhagen Stock Exchange (CSE), which is of interest because several of the more recent explanations for a stock market reaction can be ruled out in the case of the Danish stock market. The main findings are that the announcement effect of stock dividends as well as stock splits is closely related to changes in a firm's payout policy, but that the relationship differs for the two types of events.

A stock dividend implies an increase in nominal share capital and hence a decrease in retained earnings. Firms announcing stock dividends finance growth entirely by debt (explaining the need for an increase in nominal share capital) and retained earnings. All firms announcing a stock dividend with a split factor of less than two can also afford to increase their cash dividends permanently, at least proportionally to the increase in share capital, leading to a significant announcement effect of 4.23%. Firms announcing a stock dividend with a split factor of two or more also increase cash dividends, but less than proportionally to the increase in share capital. This leads to an insignificant announcement effect of 0.08%. These findings are in support of a retained earnings/signaling hypothesis.

For stock splits, no separate announcement effect was found when a firm's payout policy was controlled for. This lends support to the idea that a stock split per se is a cosmetic event on the CSE and is also consistent with the fact that making a stock split on the CSE is virtually cost free.

Keywords: Stock splits, Stock dividends, Cash dividends, Signaling, Liquidity

JEL Classification: G14, G32, G35