This chapter examines the valuation effect of stock spit announcement (policy) on firms quoted at the Egyptian Stock Exchange. The chapter has five major parts based on the specific objectives of the study that seek to answer the following questions: Is there a significant correlation between stock split declaration and splitting firm’s stock price? Do stock splits have an impact on splitting firm’s stock liquidity “trading volume “? Do stock split announcements affect splitting firm’s volatilities on prices”? According to (Brennan and Copeland, 1988), stock splits are informative to the market in two ways. First, they can be used to gesticulate the firm’s private data about future scope. Second, they can help attract the interest of more analysts and investors and thus lead to a positive revaluation of the stock.
1. Stock split definition
Stock split is the operation of splitting the nominal par value shares into smaller according to the particular stock split ratio, where the nominal value changes only resulted additional total shares, but does not change total issued and paid-up capital or will not diminish or enlarge the venture capital value from shareowner or investor (Hamzah, 2006).
Stock split will change shares ownership composition owned by shareholder..Stock split according to (Halim, 2005) is split into greater number of sheets using a lower nominal value per share proportionately. Stock split purpose in order to keep stock price not too high so it’s more common in the commonality and the more trafficked. With stock split, shareholder must convert his old shares to new shares have a nominal value lower in specified time , if the shareholder went beyond the specified time ,the old shares with a nominal value can’t be traded on an exchange market .
Stock split publication very important information to shareholder and prospective investor. Information obtained from companies that do stock split, may be used by shareholder for consideration in the preparation portfolio and potential investor can use to consider the decision whether to buy or not to buy shares for optimal benefit to risk as low. Besides stock split information to attract investor and provide a return for investors if the dividend paid greater (Ahmad, 2004)” .
A stock split is an accounting transaction that increases the number of shares of stock held by existing shareholders in proportion to the number of shares currently owned by these shareholders. A stock split entails a reduction in the par value of the corporation’s stock and the simultaneous exchange of a multiple number of new shares for each existing share (Sharpe, Alexander, Bailey (1995)
Stock split information is one of corporate act which strives to increase company value. Stock split provides information to investor about prospect of substantial future return, increasing return can be foretold signal on short-term and long-term profit. Stock split announcement considered as a signal given by management to the public that a company has good prospect in the future”. Study result conducted by Miliasih (2000), Sutrisno (2000), Fatima 2010), Sadikin (2011), and Astuti (2012) does not maintain this theory. Study result conducted did not find any abnormal return associated with stock split announcement. But the other study results managed by Sudiro (2000), Kurniawati (2003), Rusliati and Farida (2010), and Sadikin (2011) showed that around stock split announcement showed abnormal stock price behavior by reason of the market participant’s reaction on the Stock Exchange markets
As an alternative to splitting its stock, a company may also choose to pay dividends in the form of stock. Stock dividends are similar to stock splits in that the proportionate ownership of existing investors remains unchanged. For instance, in a 10% stock dividend, a shareholder receives one new share for every 10 shares he owns. Similar to stock splits, if a company has 1,000,000 shares of common stock outstanding and declares a 10% stock dividend, the company ends up with 1,100,000 shares outstanding following the distribution of the stock dividends. There are two basic differences between a stock split and a stock dividend. The first difference is the magnitude of change in the number of shares outstanding. The post-split number of shares is usually larger by an amount of 25% or more compared to the pre-split number of shares in a stock split. On the other hand, a stock dividend is usually associated in an increase of less than 10%. The second difference between a stock split and a stock dividend is the accounting treatment. In case of a stock split, all the old shares are destroyed and new shares are issued with a new par value. For instance, in a two-for-one stock split, the 4 number of outstanding shares is doubled and par value is halved. In case of a stock dividend, a bookkeeping entry is made transferring “retained earnings” to common stock. For instance, if a firm with 1,000,000 shares outstanding with a pre-split price of $10 declares a 10% stock dividend, the accountant would show 100,000 new shares outstanding and transfer 100,000($10)= $1,000,000 from “retained earnings” account to “common stock”. Thus the level of retained earnings puts a limit on the size of the stock dividend for a given firm.
Another version of a stock split is the “reverse” split. This is the opposite of an ordinary split. When a company engages in a reverse stock split, it exchanges one share of stock for a predetermined number of shares of stock. A reverse split does not increase the market capitalization of the company. This procedure is typically used by companies with low share prices who would like to increase their share prices to either gain more respectability in the market or to prevent the company from being de-listed from the stock exchange.1 Alternatively, a company may want to conduct a massive reverse split to eliminate small investors from its shareholder base. For instance, in a reverse 5-for-1 split, 10 million outstanding shares at 50 cents each would be changed to only 2 million shares outstanding at $2.50 each. Both before and after the reverse split, the company is only worth $50 million. Just like the case of ordinary splits, following a reverse split, there is no theoretical reason to expect a change in the stock price beyond the adjustment for the split itself. Empirically, it has been shown that after most reverse splits, the stock price declines. The reasons for such a decline are posited to be the opposite of the reasons for the price increases following ordinary splits
.“The shapes of stock split (can be divided into two divisions) according to Samson (2008)
Split up, it means that reducing the par value per share which resulted in increase the total share outstanding. For example, a stock split with a splitting factor of 1:2, 1:3, 1:10 and so on.
Split down (converse stock split), it is an action which decreases the total share outstanding. The Split down aims to increase the stock price in the market in order to improve corporation image. Split down can be done by pulling back the total share outstanding and replaced with the new share higher par value , but does not change the total paid in capital and total equity. Split 5:1 means five old shares replaced with one new share.
Understanding Stock Splits, Say you had a L.E100 bill and someone offered you two L.E50 bills for it. Would you take the offer? This might brings to mind a senseless question, but the action of a stock split puts you in a similar situation .A stock split is a corporate deed that enlarges the number of the corporation’s outstanding shares by dividing each share, which in turn reduces its price. The stock’s market capitalization, however, remains the same, just like the value of the L.E100 bill does not change if it is exchanged for two L.E50s. For example, with a 2-for-1 stock split, each investor receives an additional share for each share held, but the value of each share is reduced by half: two shares now equal the original value of one share before the split. Let’s say stock A is trading at L.E40 and has 10 million shares issued, which gives it a market capitalization of L.E400 million ( L.E40 x 10 million shares). The company then decides to carry out t a 2-for-1 stock split. For each share shareholders currently own, they receive one additional share, deposited directly into their brokerage account. They now have two shares for each one previously held, but the price of the stock is cut by 50%, from L.E40 to L.E20. Notice that the market capitalization stays the same – it has doubled the amount of stocks outstanding to 20 million while at once reducing the stock price by 50% to L.E20 for a capitalization of L.E400 million. The true value of the company has not changed at all .
The most common stock splits are, 2for1, 3-for-2 and 3-for-1. An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide L.E40 by 2 and we get the new trading price of L.E20, If a stock were to split 3-for-2, we’d do the same thing: 40/(3/2) = 40/1.5 = L.E26.6.It is also possible to have a reverse stock split: 1-for-10 means that for every ten shares you own, you get one share .
due to the different outcomes of studies and technical researches in regards to the impact of stock split policy on the share market value; in addition to the existence of deception with the splitting decree by some companies, and in the light of solicitude of the international controlling organizations to the stock markets which reverse the extent of receptiveness of stock markets to the splitting policy and its consequences. Moreover, the requirement of the initial markets to more studies in regards to the impact of splitting policy on the shares trading, activating markets, and the requirements of the small investors to acquire sufficient awareness of stock split policy; such requirements are vital due to the scarcity of scientific researches and articles that deal with the calculations and standards of stock split policy’ effect on the share market value s in the emerging markets especially the Egyptian stock market. Moreover, after many of the Egyptian companies are directed lately towards adopting such policy due to its active role in attracting small investors for contributing in stock markets, as well the consequences of this policy on the expansion of ownership of companies and activation of stock market. Thus, it becomes necessary to clarify the illustrative frame of stock split policy by reflecting its, importance and motives which companies follow the stock”
2. `The Purposes and motivations for adopting stock split
In conducting a stock split decisions every company must have a reason and purpose to be achieved. According Nany (2004), that in general the purpose of the company do a stock split to increase total share outstanding by making a cheaper stock prices so as to attract investors and companies become more liquid stocks traded on the stock exchange. The general objective is obtained from the stock split is a decrease in stock prices which further adds to the appeal to have these shares so as to make more liquid shares traded and changed the investor add lots into round lots. Add the lot is a condition in which investors buy shares below 500 pieces (1 lot), while the round lot is the investor who bought the stock at least 500 sheets (1 lot). Meanwhile,
What the motivation of stock split decision for the managers?
The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more “attractive” level. The effect here is purely psychological. The actual value of the stock doesn’t change one bit, but the lower stock price may affect the way the stock is perceived and therefore attract new investors. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the prices rises, they have more stock to trade.
Another reason, and arguably a more logical one, for splitting a stock is to increase a stock’s liquidity, which increases with the stock’s number of outstanding shares
There are plenty of arguments over whether a stock split is an advantage or disadvantage to investors. One side says a stock split is a good buying indicator, signaling the company’s share price is increasing and therefore doing very well. This may be true, but on the other hand, a stock split simply has no effect on the fundamental value of the stock and therefore causes no real advantage to investors. Despite this fact, investment newsletters have taken note of the often positive feeling surrounding a stock split. There are entire publications devoted to following stocks that split and attempting to profit from the optimistic nature of the splits. Critics would say this strategy is by no means a time-tested one and is questionably successful at best.
Due to commissions weighted by the number of shares you bought. It was advantageous only because it saved you money on commissions. This isn’t such an advantage today as most brokers offer a flat fee for commissions, charging the same amount for 10 shares or 1,000. Some online brokers have a limit of 2,000 or 5,000 shares for a flat rate; however most investors don’t buy that many shares at once