The Market Valuation of Bonus Issues in an Inflationary Environment

Cahit Adaoglu*
Faculty of Business and Economics
Eastern Mediterranean University
Gazimagusa, Mersin 10 Turkey

M. Ameziane Lasfer
Cass Business School
City University
106 Bunhill Row
London EC1 8TZ U.K.

Abstract
This paper assesses the market valuation of an unusual form of free stock distributions called
bonus issues which are mainly financed by the revaluations of assets equity reserve in an
inflationary economic setting. We detect positive excess return on the announcement day for
these bonus issues similar to the market reaction to stock dividends and splits in developed
and emerging markets. In an institutional environment where cash dividend substitution
effect, agency cost effect, transaction cost effect and retained earnings effect are not present,
we find empirical support for the enhanced liquidity hypothesis, but interestingly, no support
for the attention getting hypothesis and the signaling hypothesis which is the predominant
explanation for the positive market reaction to the stock distributions in developed capital
markets. We also provide a unique explanation for bonus issues as corporations need to
increase their eroding paid-in capital in an inflationary environment in order to have a better
debt to paid-in capital ratio for more credibility and borrowing capacity in a market of limited
access to external equity financing.

JEL Classification: G35

Keywords: Bonus Issues, Stock Dividends, Stock Splits, Signaling, Liquidity, Neglected

Version: May 2008

*
Address for corresponding author: Dr. Cahit Adaoglu, Faculty of Business and Economics, Eastern
Mediterranean University, Gazimagusa, Mersin 10, TURKEY, Tel. (+90) 392 630 2116, Fax (+90) 392 365
1017. E-mail: cahit.adaoglu@emu.edu.tr (Adaoglu); m.a.lasfer@city.ac.uk (Lasfer).
1. Introduction

Stock distributions either by stock splits or stock dividends are puzzling corporate

behavior. Theoretically, these distributions are cosmetic operations aimed at dividing the

corporate pie into more pieces with no change in the total value of the firm. However, the

empirical studies report significant positive market reaction to these decisions on the

announcement day.1 This positive market reaction is often related to a combination of the

signaling, the liquidity and marketability, the trading range and the retained earnings

hypotheses. However, this positive reaction is still controversial as stock distributions can be

substitutes to cash dividends (e.g., Baker et al., 1995) and allow managers to increase their

flexibility in the corporate dividend policy (Jensen, 1986; DeAngelo et al., 1992). Stock

distributions, therefore, exacerbate the free cash flow problem as managers can retain more

cash in the corporation avoiding the market monitoring that results from external financing.

In this case, the market is expected to react negatively on the announcement date and this

effect is known as the cash substitution hypothesis.

In this paper, we examine the market valuation of an unusual form of stock

distributions called “bonus issues”. We use the Istanbul Stock Exchange (ISE), an emerging

stock market, as a testing ground where corporations distribute regularly bonus/free shares on

a pro rata basis in an inflationary environment by using accumulated equity reserves,

especially the revaluation of assets reserve known as “inflation revaluation equity reserves”

in Turkey2. In the ISE, stock distributions are classified into bonus issues and stock

dividends3, and the difference between the two is clear cut. In other prominent emerging

markets such as China, India, Australia and Greece, bonus issue is the term used for “free”

issues of shares from accumulated capital reserves and/or retained earnings/distributable

profit. In the ISE setting, “bonus issue” term is used only for “free” shares financed from

accumulated equity (capital) reserves and “stock dividend” term is used only for “free” shares

1
financed from distributable profit and/or retained earnings. In the United States and in other

developed countries, bonus issues are widely known as stock dividends and in the U.K., as

scrip dividends.

We test the signaling, liquidity and attention getting hypotheses in a closely held

market structure where bonus issues are not substitutes for cash dividends as they emanate

from an accounting treatment in a high inflationary environment. These bonus issues allow us

to eliminate the cash dividend substitution and agency cost effects as these issues are not

financed by retained earnings/distributable profit and do not change the ownership

distribution (i.e., the typical existing ownership structure between the family group and the

remaining shareholders is not altered). Moreover, since the transaction costs are based on the

total amount of the transaction rather than on the total number of shares, the transaction costs

are not changed due to the bonus issues. Retained earnings effect is not present as well since

these issues are not financed by retained earnings.

Specifically, the market reaction is examined for different combination of

capitalization reserves such as the bonus issue capitalizations from “inflation revaluation

equity reserves”, “capital gain equity reserves” and “other equity reserves”. As Rankine and

Stice (1997) show, the event classification and the source of capitalization are important due

to the potential effects on the announcement reaction. They show that classifications (stock

splits, large and small stock dividends4) by CRSP database in the U.S. are not reliable and by

correcting the classifications, they find significant differences between two-for-one stock

dividend and stock split announcements. In their article, stocks dividends financed by funds

other than retained earnings is called “capital surplus” stock dividends similar to the bonus

issue accounting treatment in Turkey. Rankine and Stice explore the differences in market

reaction for stock dividends capitilized by different equity reserves. They find that stock

dividends reducing capital surplus has a lower market reaction (2.45%) relative to the market

2
reaction of stock dividends reducing retained earnings (3.67%), but the difference is not

statistically significant.

We find that, on average, the announcement date abnormal returns are positive

(2.79%) and statistically significant as a market reaction. Classified by the source of

capitalization, we find statistically significant positive market reaction of 2.92%, 3.52%,

1.65% for bonus issues financed by inflation revaluation reserves only (Category 1), by

combination of inflation revaluation and other equity reserves (Category 2), and by reserves

including capital gain equity reserves (Category 3) respectively. We have some empirical

evidence for the difference in the magnitude of market reaction to bonus issues financed by

these three categories, but due to the contamination of the announcement with different

combination of reserves, the empirical evidence for difference is not strong, especially for the

bonus issues financed by capital gain equity reserves which provide taxation advantage for

the corporation.

In our regression analysis, the pre bonus issue market price and market value

significantly affect the bonus issue size, and the abnormal returns are significantly related to

the bonus issue size and the pre bonus issue market price. Additionally, the liquidity

measures are positive and statistically significant indicating that bonus issues increase the

liquidity (market depth) of the stocks traded. While these results are consistent with the

enhanced liquidity hypothesis, the univariate analysis of operating margin (%) and the

regression analysis of abnormal returns do not provide support for the signaling hypothesis.

The insignificance of the signaling hypothesis is in line with our expectation given the ISE’s

institutional settings of frequent issue of bonus issues, unstable dividend policies, low cost of

sending false signals in a closely held market structure and cost neutral transaction costs. We

also find no empirical evidence for the attention getting hypothesis due to the insignificant

relationship between the abnormal return (market reaction) and the size of the corporation.

3
 The unique result of this paper is that the univariate analysis of the financing policies

of corporations issuing bonus issues and the regression results of the determinants of bonus

issue size indicate corporations need to increase their eroding paid-in capital in an

inflationary environment in order to have a better debt to paid-in capital ratio for more

credibility and borrowing capacity in order to finance their growth in a market of limited

access to external equity financing.

The rest of the paper is structured as follows. Section 2 discusses the accounting and

taxation treatment of bonus issues, different sources and combinations of capitalization

reserves along with descriptive bonus issue statistics compiled from the population collected

for the study. Section 3 reviews the literature presenting the prominent hypotheses and the

testable hypotheses in the ISE institutional settings. Section 4 presents the sample data and

the methodologies. Section 5 reports the empirical results followed by the conclusions in

Section 6.

2. Bonus Issues by Corporations Traded in the Istanbul Stock Exchange and

Inflation
Bonus issues are issued by using accumulated equity (capital) reserves known as

“internal resources” in Turkey. Taking into account the reserve characteristics, these

accumulated equity reserves can be categorized under three headings, namely “inflation

revaluation equity reserves”, “capital gain equity reserves” and “other equity reserves.” The

“inflation revaluation equity reserves” include the equity accounting entries, namely, the

asset revaluation reserve, the cost revaluation reserve and the paid-in capital inflation

adjustment reserve. Till the end of 2003, the asset revaluation reserve and the cost revaluation

reserve were used as equity accounting entries in which the fixed assets were adjusted for

inflation by a constant ratio announced by the Ministry of Finance periodically. Adjusting the

4
book value of fixed assets for inflation allowed the corporations to fully utilize the tax shield

advantage of depreciation expenses in an inflationary environment and avoid the inflation

taxation. In 2004, with the implementation of international inflation accounting standards and

declining trend in the inflation, these two revaluation reserves were abolished and the paid-in

capital inflation adjustment reserve is introduced. “Other reserves” include the share

premium equity reserve and mandatory special equity reserve which are not related to

inflation revaluation. Corporations are allowed to transfer these equity entries to paid-in

capital by issuing bonus stocks to shareholders and these bonus stocks are tax-free.

The “capital gain equity reserves” include the reserves of capital gain from the sale of

participation shares and capital gain from the sale of corporation property. The capital gain

from these sales were tax-free for the corporation only if the corporation transferred these

reserves to paid-in capital by issuing bonus issues to shareholders. The government

motivation behind this tax-exemption was to strengthen the capital structure of the Turkish

corporations. However, for sales after the second quarter of 2006 which is not included in our

sample period, the requirement of issuing bonus issues by transferring these reserves to paid-

in capital is abolished and only 75% of the capital gains is tax free. As it is the case for bonus

issues funded from other reserves, bonus stocks distributed to shareholders from the “capital

gain equity reserves” are tax-free.

[Insert Table 1]

For the period 1986-2006, all seasoned equity issues are compiled from the ISE

database ISE Companies Capital Increases and Dividend Payments 1986-2007/065. By using

this official database, a total of 1,326 bonus issues by non-financial corporations traded in the

ISE are collected for further analysis. In Table 1 (Panel A), some descriptive statistics are

provided for the bonus issue population. It should be noted that bonus issue ratios (% of paid-

in capital) range from 0.1% to 11,300% with an average and median values of 166% and 75%

5
respectively. These percentages are in contrast with the New York Stock Exchange rules that

prescribe the NYSE corporations to make share distributions of less than 25% through stock

dividends rather than stock splits.

[Insert Figure 1]

In Figure 1, the relationship between the average percentage increase in paid-in

capital by “internal resources” and the consumer price inflation is demonstrated. Between

1986 and 2000 during which the inflation rate was mostly above 50%, the average percentage

increase followed the inflation trend, and due to the economic crisis in 2001 and the

following considerable decline in the inflation rate as a result of the implementation of major

economic reforms, the average percentage followed an erratic trend except for declines in

2005 and 2006. There is a significant decrease in 2005 and 2006 due to the fact that with the

implementation of inflation accounting standards, 2004 was the last year for distributing

bonus issues from the asset revaluation and cost revaluation funds.

In Table 1 (Panel B), bonus issue frequency ratio is calculated using only the non-

financial corporations with at least five years of trading data and is calculated as the number

of bonus issues divided by the number of trading years in the ISE. The mean and median are

same with a value of 40% indicating that corporations issue on average 2 bonus issues every

5 years of trading. 33% of corporations issued bonus shares more than 2.5 times in 5 years of

trading indicating that stock distributions in the form of bonus issues is a frequently used

corporate policy in the inflationary environment of Turkey.

3. Theoretical Background and Testable Hypotheses in the ISE settings

The positive market valuation of stock distributions has been well established in the

U.S. literature with several hypotheses trying to explain this positive valuation effect which is

6
predominately explained by the signaling hypothesis. The other not mutually exclusive

explanations are the liquidity, trading range, neglected firm (attention-getting), cash

substitution and retained earnings hypotheses.

The positive announcement effect in several studies of stock distributions is

interpreted as evidence in favor of the signaling hypotheses. The signaling hypothesis states

that, in the presence of asymmetric information, corporations issue stocks to signal good

news or optimistic expectations to investors (e.g., Nichols, 1981; Grinblatt et al., 1984;

McNichols and Dravid, 1990; Woolridge, 1983; Banker et al., 1993; Peterson et al., 1996;

Rankine and Stice, 1997) and managers are likely to signal that they will have larger

increases in future earnings in order to at least maintain or increase their cash dividends and

earnings per share.

According to the enhanced liquidity hypothesis, the positive abnormal returns are

related to the possibility that since stock distributions increase the number of shares in

circulation, they increase the liquidity and marketability, and result in a decrease in the bid-

ask spread. The other form of enhanced liquidity is the trading range hypothesis stating that

the motive behind stock distributions is to move the stock price into a normal or optimal

trading range attracting more investors and hence, increasing liquidity. However, the

empirical evidence on the liquidity effect is mixed and inconclusive (e.g., Copeland, 1979;

Murray, 1985; Lakonishok and Vermaelen, 1986; Lakonishok and Lev, 1987; Lamouoreux

and Poon, 1987; Conroy et al., 1990; McNichols and Dravid, 1990; Ikenberry et al., 1996).

The neglected firm or the attention getting hypothesis states that managers who

believe that the stock is currently undervalued use the stock distribution as a tool for

attracting attention from analysts resulting in the revaluation of their future cash flows

(Grinblatt et al., 1984; Arbel and Swanson, 1993).

7
 In relation to the dividend policy, especially in the case of stock dividends, the cash

substitution hypothesis states that managers can keep the cash in the corporation and at same

time, satisfy the shareholders by distributing “free” shares. However, the predicted market

reaction is negative as opposed to positive market reaction prediction of the preceding

hypotheses. Banker et al.’s (1993) study find negative market reaction for announcements of

cash dividend omissions especially for corporations with no prior “free” stock distribution

history. Another recent dividend policy related hypothesis is the retained earnings hypothesis

which tries to explain the different magnitude of positive market reaction to the two forms of

“free” stock distributions, namely stock dividends and stock splits. The hypothesis states that

stock dividends incorporate stronger signals as they decrease the pool of distributable funds

signaling that managers believe in strong future cash flows in order to have a stable dividend

policy (Rankine and Stice, 1997; Crawford et al., 2005; Bechmann and Raaballe, 2007).

Consistent with the hypotheses above and taking into the ISE institutional settings;

Hypothesis 1: Corporations are expected to have positive market reaction to the bonus

issue announcements.

In the Istanbul Stock Exchange, since bonus/free shares are distributed frequently on a

pro rata basis by using accumulated equity reserves, especially the revaluation of assets

reserve, their decision cannot be related to the cash substitution, the retained earnings and the

agency cost hypotheses. This institutional setting allows us to focus on three hypotheses,

namely the signaling, the neglected firm and the liquidity hypotheses.

The interesting observation regarding the bonus issue distributions in the ISE is the

significantly high magnitude and frequency of these distributions. Since companies in the ISE

distribute bonus issues frequently, they are unlikely to time their bonus issue distributions

weakening the signaling effect. Moreover, another weakening effect on the signaling effect is

8
that corporations trading in the ISE follow unstable dividend policies6. Adaoglu (2000) shows

that, unlike the stable and sticky dividend policy behavior in developed capital markets,

corporations trading in the ISE follow unstable dividend policies. Another factor weakening

the signaling effect is the low cost of sending false signals. For a signaling device to be valid,

there should be a cost associated with sending a false signal such as the case for stock splits

resulting in administrative costs and the increased transaction costs for investors. The

brokerage commission in the ISE is based on the total market value of the transaction unlike

the case in the U.S. where it is based on the number of shares traded. Consequently, the

transaction costs incurred by investors are not altered by bonus issues and the administrative

cost of the frequent bonus issues is low7. Additionally, the closely held ownership structure,

especially family controlled corporations, diminishes the need to use the bonus issues as a

signaling device. Consequently, the market reaction to bonus issues based on the signaling

effect in the ISE is expected to be none or lower than the U.S. empirical evidence on

signaling effect.

The market reaction to stock distributions in the ISE is likely to reflect enhanced

liquidity rather than signaling. The ISE investors are typically short-term investors (e.g.,

Bildik and Gulay, 2007). For example, Ozden (1996) reports that short-term capital

appreciation is the paramount investment concern of investors in the ISE while the dividend

income is clearly at the bottom of their concern list. The lack of long-term institutional

investors in the ISE makes the market very volatile which is a typical characteristic of all

emerging markets. Based on the observations of low diffusion of ownership and an average

public openness (free float) of 24% in the ISE, financial practitioners in Turkey argue that

equity issues are welcomed by investors since new equity issues, especially bonus issue

distributions, increase the number of shares in circulation resulting in enhanced liquidity and

marketability. Additionally, bringing the stock price into an optimal trading range can be

9
another motivation for bonus issues especially taking into account the fact that there has been

a significant growth in the ISE index during the study period. Within the framework of

attention getting, bonus issues can also be used as a tool to attract the analysts’ attention. It is

expected that the announcement effect will be positive reflecting the positive effects of

enhanced liquidity and marketability, and attention getting hypotheses.

Hypothesis 2: The liquidity and the neglected firm effect proxies are expected to be

associated with the market reaction, but not the information signaling proxy for better future

earnings.

Booth et al. (2001) show that there is a country effect on the determinants of capital

structure focusing on the capital structures in several developing countries including Turkey.

They conclude that different institutional factors can result in different capital structures as

well as different corporate governance systems. Unlike the market oriented countries such as

the U.K. and the U.S., the amount of paid-in capital has more legal as well as corporate

policy implications in the bank oriented countries such as Turkey, Germany, Denmark and

Switzerland (Booth et al, 2001; Wulff, 2002; Kunz and Rosa-Majhensek, 2007; Bechmann

and Raabelle, 2007). Even though the proportional increase in the paid-in capital favors the

debtholders at the expense of shareholders due to greater security, in Turkey, with

institutional settings of high inflation, weak shareholder rights and high creditor rights, heavy

dependency on short-term bank financing for growth, unavailable corporate bond market and

closely held ownership structure8, shareholders in the ISE welcome the paid-in capital

increases due to positive effects on borrowing capacity for growth as well as due to the fact

that paid-in capital (i.e., known as legal capital in the U.S. and generally defined as the total

par values of outstanding shares) has more legal protection than the other equity items that

can be abused by the controlling shareholders, typically family members controlling the

management and voting power both in the board of directors and shareholder meetings. For

10
instance, dividends can not be paid out of legal capital and it is very difficult to decrease the

legal capital due to stringent legal protections. In the announcements, board of directors

typically state that the paid-in capital will increase due to the bonus issue distribution.

Similarly, in Denmark, Bechmann and Raaballe (2007) state that even though share capital

increases through stock dividends improve security for creditors, “…this appears to be a

necessary step for these firms in order to finance steady growth by debt (at an unchanged debt

to equity ratio) and retained earnings alone” (p.602).

Gonenc (2003) shows that due to high inflation, political and economic uncertainty in

Turkey, financial structure of Turkish industrial corporations in the ISE are heavily

dependent on short-term debt with an average 12% long-term debt to total debt ratio for the

period 1990-19999. In these economic conditions, Gonenc states that it is very difficult to find

external equity and corporations need bank financing to support their growth. Interestingly,

unlike the relationship found in developed and some developing countries, Gonenc shows

empirically that there is a positive relationship between the growth opportunities and the debt

ratio due to the institutional characteristics of Turkish corporations and economy.

Hypothesis 3: In an inflationary environment, the increase in paid-in capital is

expected to be associated with the market reaction as well as with the bonus distribution ratio.

As stated in Section 2, in order to avoid the corporation tax, the VAT and stamp

duties, corporations were required to transfer any capital gain from property sale and/or sale

of participation shares to paid-in capital through bonus issues. Even though there is a tax

advantage for the corporation, the sale of property and/or participation shares can also

indicate cash squeeze problem for the corporations. Consequently, both negative and positive

effects are present affecting the expected magnitude of the market reaction.

11
 Hypothesis 4: Bonus issue announcements that include the bonus issues financed

from “capital gain equity reserves” are expected to have different market reaction relative to

the bonus issue announcements that include the “inflation revaluation equity” and/or “other

equity” reserves.

4. Data and Methodology

We identify 161 uncontaminated bonus issue distribution news10 that are announced

by non-financial corporations (i.e., excluding utilities, banks, insurance, holding, finance and

investment companies) in the official ISE daily bulletin over the period 1995-200611 by

searching through the electronic news database in the Finnet Haber Analiz 4.0© software.

The adjusted/unadjusted stock prices and trading volume data are obtained from the

electronic databases Tekaredi-Veri v.1.1.5© and Rasyonet Hisse XL v.2.3.2© software.

[Insert Table 2]

Table 2 presents the descriptive statistics for the bonus issue announcements sample

as well as the sources of capitalizations. In 155 out of 161 bonus issue announcements, the

sources of capitalizations are announced by the Board of Directors. As it can be seen in Panel

A and Panel B, 110 of 155 (70%) bonus issues includes the “inflation revaluation equity

reserves” and in terms of total amount in New Turkish Lira (YTL), they account for 81% of

the total. In 30 out of 155 (30%) bonus issue announcements, “capital gain equity reserves”

are used mainly due to the corporation tax advantage, but they account only for 5% of the

total amount of bonus issues in YTL.

As shown in Panel C, the average (median) bonus issue ratio measured as a

percentage of paid-in capital12 in the ISE are 221% (100%) which is substantially higher than

other markets such as 100% in India, 69% in Greece, 30% in China, 18% in Australia, 11%

in US and 9% in Japan (Lukose and Rao, 2002; Papaioannou et al., 2000; Balachandran et al.,

12
2004; Lakanishok and Lev, 1987; Kato and Tsay, 2002). Panel C shows that 85% of bonus

issue distributions are between 1% and 300%. In terms of distribution ratio, the bonus issue

distributions in the ISE are more similar to the stock split factors, but still at a significantly

higher magnitude relative to 85% average stock split distribution in the U.S. (Lakonishok and

Lev, 1987). However, as stated before, bonus issues are different in terms of accounting

treatment relative to stock splits.

4.1 Market reaction

We adopt the traditional event study approach to assess the market reaction to bonus

issue announcements by using the market adjusted model13 using the estimation period -140

to -2114 relative to the event day 0. The event window is taken as -5 to +5 relative to the

announcement day during which there are no other corporation specific news other than the

bonus issue announcement. Three announcement sub-event periods are also defined as the

pre-event period (-5 to -1), the announcement day (event) period (0 to +1) and the post-event

period (+2 to +5). The cumulative market reaction (CAR) for each sub-event period is also

calculated and is tested for statistical significance. The return on the market portfolio is

proxied by the value-weighted ISE 100 index which includes 100 corporations based on their

market value and liquidity characteristics. The ISE 100 index is a representative index and is

the most widely used index by the investment banking industry as well as by the financial

researchers as a proxy for the market return. Moreover, it is the only index whose data is

available for the period of analysis. The non-parametric generalized sign test is also used as a

robustness check in order to avoid the dependence on normality of return distributions.

4.2 Liquidity

13
 In the literature of stock distributions, the three most commonly used measures of

trading activity are the volume (daily number of shares traded), the volume turnover (daily

number of shares traded divided by shares outstanding) and the number of days with trades.

We do not use the volume turnover since on average, the free float percentage of outstanding

shares is around 25% in the ISE and there is a lack of percentage free float data for specific

periods15. We could not use the number of days of trading yardstick since all stocks in our

sample do not have any missing trading data. Alternatively, we adopted the following

yardsticks for testing the enhanced liquidity effect.

In line with arguments of Amihud et al. (1997) for the case of the Tel Aviv Stock

Exchange, liquidity of stocks cannot be measured by bid-ask spreads in the ISE, since there

are no market makers or specialists who post bid and ask prices. In the ISE, it is the investors

providing liquidity to the market by entering their limit orders into the electronic trading

system. Investors act as market makers and do not have to hold stock inventories in the ISE’s

price competitive and order-matching trading system (multiple price continuous auction

system). We follow Amihud et al. (1997) and use three different measures of liquidity,

namely the stock’s raw and relative trading volume, and the stock’s market depth ratio.

Theoretically, stock’s trading volume is an increasing function of its liquidity, ceteris paribus

(Amihud and Mendelson, 1986). Therefore, an increase (decrease) in the trading volume

shows an increase (decrease) in liquidity.

The change in raw trading volume for security i is measured as the difference between

ln(VOLi,after) and ln(VOLi,before) where VOLi,after and VOLi,before are the average daily trading

volume in lots before the announcement day and after the ex-day. The average trading

volumes are calculated for the period (-140 to -21) before the announcement day and for the

period (+21 to +140) after the ex-day16. Similarly, the change in relative trading volume for

security i is measured as the difference between ln(relVOLi,after) and ln(relVOLi,before) where

14
relVOLi,after and relVOLi,before are the average daily relative trading volume in lots. The daily

relative trading volume in lots is calculated by dividing the unadjusted trading volume by

market volume for each day.

The third measure is the market depth ratio which is considered as a good proxy for

liquidity in several microstructure studies (e.g., Khan and Baker, 1993; Berkman and

Elaswarapu, 1998; Muscarella and Piwowar, 2001). The market depth ratio measures the

trading volume associated with a unit change in the stock price. In other words, a high ratio

indicates that investors can trade a large number of shares with little price change. Therefore,

an increase (decrease) in the market depth ratio shows an increase (decrease) in liquidity or

market depth for a stock. The ratio is measured as:

m m

MD
k ,m
i
= ∑V i ,t ∑R i ,t
(1)
k k

where Vi,t and |Ri,t| are the trading volume in lots and the absolute return respectively for

stock i on day t, comparing the MD for the period (-140 to -21) before the announcement day

to the MD for the period (+21 to +140) after the ex-day. The change in the market depth

ratio for security i is measured as the difference between ln(MDi,after) and ln(MDi,before).

Taking into account the finding by Wulff (2002) for the German stock splits that less

liquid shares have a relatively larger improvement in liquidity and a stock split does not

improve liquidity if the stock’s liquidity is already high, the sample is portioned into three

groups (1-50, 51-100, 101-153) sorted by the pre-bonus issue average raw and relative

trading volume, and market depth. The statistical significance of mean and median changes

for all and sorted groups is tested by using the parametric paired t-test and the non-parametric

Wilcoxon test respectively.

4.3 Univariate analysis: Operating performance and financing

15
 We use the operating margin (%)17 as a proxy for the signaling hypothesis in an

univariate analysis framework. We test the hypothesis that if companies issue bonus shares to

signal good future performance, we would expect an increase in operating margin in the post-

event period. We use only one year operating margin in the pre-event and post-event periods

in order to avoid the previous and subsequent bonus issues by the same corporation.

Taking into account the heavy dependency on short-term borrowing by the ISE

industrial corporations and the eroding paid-in capital in an inflationary environment, we

analyze the financial structures of our sample corporations by using several financial ratios

such as debt to equity ratio (%), debt to paid-in capital ratio (%), total debt growth rate (%),

short-term debt to total debt ratio (%) and short-term debt growth rate (%). We try to provide

evidence whether there is a need for an increase in the paid-in capital in order to finance

growth by borrowing. Similar to the operating margin’s time period analysis, we calculate

these ratios for the pre-event year, the event year and the post-event year. Using parametric t-

test and non-parametric Mann-Whitney U-test, we test for differences in mean/median for (t-

1) to t, t to (t+1) and (t-1) to (t+1) where t is the event year.

4.4 Multivariate analysis: Bonus distribution ratio and market reaction

Following the model adopted in McNichols and Dravid (1990) study, we use the

regression analysis to capture the factors that determine the bonus issue distribution ratio,

especially focusing on the enhanced liquidity effect and the debt to paid-in capital ratio

effect. Taking into account the ISE institutional settings, we regress the bonus distribution

ratio on the following explanatory variables:

BDRi = α0 + α1Pi + α2MVi + α3DCPi + εi (2)

16
where BDR is the bonus distribution ratio; P is the natural log of unadjusted stock price at the

end of quarter before the bonus issue announcement; MV is the natural log of market value of

equity in US$ at the end of quarter before the bonus issue announcement; DCP is the debt to

paid-in capital ratio at the end of quarter before the bonus issue announcement. We

approximate the liquidity explanation for bonus issue distribution by using the unadjusted

stock price (P). The relationship between the BDR and P is expected to be positive based on

the reasoning that higher stock prices need a higher BDR to bring it down to a more attractive

level. McNichols and Dravid state that larger corporations prefer to maintain a higher stock

price (i.e., a higher targeted stock price range) indicating a negative relationship between the

BDR and MV. The relationship between the BDR and DCP is expected to be positive as a

higher bonus distribution is needed to bring down the DCP ratio to a reasonable level.

We also regress the level of market reaction (CAR(0, +1)) as the dependent variable

on the following explanatory variables based on the model adopted in Rankine and Stice

(1997):

CAR(0,+1),i = α0 + α1BDRi + α2MVi + α1Pi + α4CAR(-21,-140),i + α5DBONi + α6DCGRi + εi (3)

where the definitions of BDR, MV and P are as stated above. CAR(-21,-140) is the cumulative

abnormal return for the period -21 to -140 relative the announcement day 0. The DBON is a

dummy variable having a value of 1 if the corporation does not have a bonus issue in the

previous year and captures the surprise effect; DCGR is a dummy variable having a value of

1 if the bonus issue announcement includes “capital gain reserves” as one of the sources of

the capitalization. The DCGR dummy variable tries to capture whether there is difference in

market reaction for announcements that include the “capital gain reserves” in addition to

other equity reserves. We expect a positive relationship between BDR and CAR as greater

bonus issue distribution sends a more favorable signal to investors with more free float shares

in circulation (i.e., higher liquidity). Small corporations tend to be analyzed less extensively

17
and less information is available for these corporations. Hence, we include the natural

logarithm of market value of equity (MV) and expect a negative coefficient indicating a

greater market reaction for relatively smaller corporations (i.e., attention-getting

hypothesis/neglected firm hypothesis). Since stock distributions can be used as a tool of

returning the stock price to an optimal trading range, corporations with a higher stock price

(P) are more anticipated by the market to declare a bonus issue distribution indicating a

negative relationship between the market reaction and the stock price (Rankine and Stice,

1997). Lastly, as a proxy for signaling hypothesis, we use the pre bonus distribution run up

(CAR(-21,-140)) since if a bonus distribution is a costly signal, managers would announce a

bonus issue distribution if they believe that the run-up reflects fundamental value and there is

a momentum of prices into the future (Leledakis et al., 2008).

5. Empirical findings

In Table 3, the daily mean abnormal returns, the cumulative abnormal returns for the

selected periods, the percentage of positive mean abnormal returns along with the t-value and

the generalized sign test result for each event day are presented. The mean abnormal returns

on event days 0 and +1 are 1.79% and 1.00% respectively with statistical significant t-values

and generalized sign tests. The cumulative abnormal return for on-event period (0, +1) is

2.79% with statistical significance (Hypothesis 1). The cumulative abnormal return for both

pre-event (-1, -5) and post-event (+2, +5) are statistically insignificant supporting the

permanency of the announcement effect and supporting the correct detection of the

announcement day as well as the robustness of the methods used in measuring the market

reaction.

[Insert Table 3 and Figure 2]

18
 Figure 2 shows the mean abnormal return and cumulative abnormal return movements

over the event period. For the cumulative abnormal return, there is a major up swing on days

0 and +1 leveling off to a permanent trend between 3.50% and 4.00%. The trends can also be

observed for mean abnormal returns with positive values on days 0 and 1 along with erratic

movements during the pre-event and post-event periods.

The positive market reaction is in line with the market reaction of “free” stock

distributions in developed and emerging markets such as U.S., U.K., Australia, Canada,

China, Denmark, Germany, Greece, Hong Kong, India, Japan, Korea and Switzerland (see

endnote 1). Specifically, the positive market reaction is in line with the announcement

reaction of 2.45% for the 100% stock dividends reducing capital surplus in Rankine and Stice

(1997) study.

[Insert Table 4]

Table 4 (Panel A) shows the on-event (0, +1) cumulative abnormal returns for three

subsamples categorized by the sources of capitalization and shows test results for testing the

differences in means/medians for these three subsamples. In shown in Panel A, we find

relatively strong statistically significant market reaction for announcements that do not

include the capital gain equity reserves. The mean (median) cumulative abnormal returns for

“inflation revaluation reserves only” announcements and combination of “inflation

revaluation reserves and other equity reserves” are 2.92% (2.31%) and 3.52% (2.21%)

respectively. For announcements that include the capital gain equity reserves in addition to all

other equity reserves, the mean cumulative abnormal return is 1.65% and the median is

0.02% indicating there is a distributional problem in this type of announcements. Moreover,

the non-parametric generalized sign test is statistically insignificant. Typically, the bonus

issues are financed with a combination several sources of equity reserves. We could not find

any uncontaminated announcements that only include the capital gain equity reserves so that

19
we can isolate the effect. The ANOVA F-statistic and Kruskal-Wallis tests could not detect

statistically significant difference in mean/medians of the three categories of capitalization.

In Table 4 (Panel B), we detect no statistically significant difference in mean/median

of “inflation revaluation equity reserves only” and combination of “inflation revaluation

equity reserves and other equity reserves.” However, we detect a statistically significant

difference in the median when the rest of all announcements is compared with the

announcements that include the capital gain equity reserves.

[Insert Table 5]

In Table 5, the three measures of liquidity, namely raw trading volume, relative

trading volume and the market depth ratio, are shown. In Panel A, the mean, the trimmed

mean and median of the difference between ln(Volafter) and ln(Volbefore) are shown for all and

sorted groups. For all, the difference results are positive but statistically insignificant. For the

first sorted group (1-50), the mean, trimmed mean and median differences are all positive

with statistical significance. The last sorted group (101-153) has a negative change in mean,

trimmed mean and median with statistical significance. The results show that less liquid

shares (1-50) have a relatively larger improvement in liquidity followed by statistically

insignificant positive change for the second sorted group (51-100) and statistically significant

negative change for the last sorted group (101-153) having the pre-announcement largest

liquidity. The results in Panel B are stronger for the relative trading volume taking into

account the effect of market volume changes. For all, the first (1-50), and the second (51-100)

sorted groups, the results are statistically significant and positive with the highest liquidity

improvement for the first sorted group with the relatively less pre-bonus issue liquidity. The

last sorted group does not have a statistically significant change in the liquidity. Overall, the

last sorted group (101-153) results indicate that a bonus issue does not improve liquidity if

the stock’s liquidity is already high. These results support the Wulff’s (2002) finding for the

20
German stock splits that the less liquid shares have the relatively larger improvement of

liquidity and might reconcile the mixed evidence on liquidity in the US empirical studies.

Similarly, for the market depth ratio in Panel C, there is a statistically significant positive

change in the market depth ratio for all bonus issues driven by the first sorted group (1-50)

which has less liquidity and is more sensitive to changes in the number of shares available in

the market. All three measures are consistent with the enhanced liquidity effect showing that

bonus issue distributions increase the liquidity (market depth) of the stocks traded in the ISE

(Hypothesis 2).

[Insert Table 6]

In Table 6, we could not detect a statistically significant change in the operating

margin for periods (t-1) to t, t to (t+1) and (t-1) to (t+1) where t is the event year. This result

supports the no signaling effect of the bonus issue distribution announcements due to the

institutional settings in Turkey (Hypothesis 2).

Focusing on the financing structures of our sample corporations, we look at several

ratios before the event, during the event and after the event. In Table 6, due to the transfer of

equity reserves to paid-in capital, there is a statistically significant decline in the mean and

median debt to paid-in capital ratio between (t-1) and (t), and then the ratio increases at (t+1)

but not to the pre bonus issue level at (t-1). With respect to total growth in debt, results show

that in the pre bonus issue and bonus issue years, there is an increase in the level of debt with

a statistically significant decline in post bonus issue year. In regards to the maturity of debt

(Short-term Debt/Total Debt), consistent with Gonenc (2003) findings, results show that

around 75% of total debt is short term borrowing with a slight decline in the post bonus issue

year. Similarly, short-term debt growth rates show that short-term debt grows in both pre and

bonus issue years with a statistically significant decline in growth during the post bonus issue

year. All preceding ratios indicate that there is an increase in the level of debt in both pre

21
bonus issue and bonus issue years indicating a need for an increase in paid-in capital as a

stronger covenant for creditors in order to finance growth through borrowing (Hypothesis 3).

Additionally, we detect no statistically significant change in the debt to equity ratio as shown

in Table 6 indicating growth in equity possibly through inflation revaluation reserves.

[Insert Table 7]

In Table 7, the regression results on the bonus distribution ratio choice (model 2) are

presented and the results are in line with the findings of McNichols and Dravid (1990). The

intercept and all coefficients are statistically significant with an adjusted R2 of 40.37%. The

coefficients of pre bonus issue market price and the market value have the predicted sign

supporting the enhanced liquidity hypothesis (Hypothesis 2). Managers set their bonus

distribution ratio to return the stock price to an optimal range and the optimal range is set

higher for larger corporations. Additionally, the coefficient of debt to paid-in capital ratio has

the predicted sign supporting the hypothesis that corporations with a higher debt to paid-in

capital ratio declare a higher bonus distribution ratio to bring down the ratio for more

credibility and borrowing capacity (Hypothesis 3).

[Insert Table 8]

The regression results for the cumulative abnormal return and the five explanatory

variables are presented in regression 1 of Table 8. As predicted, the coefficients of bonus

distribution ratio (BDR) and the pre bonus market price are positive and negative respectively

with statistical significance. The coefficients of the market value (MV) and bonus dummy

(DBON) have the correct sign but are statistically insignificant. The CAR(-21,-140) coefficient

has the wrong sign and is statistically insignificant. Overall, the statistically significant BDR

and P coefficients support the enhanced liquidity hypothesis. We could not find empirical

support for the attention-getting/neglected firm hypothesis with a statistically insignificant

22
MV coefficient (Hypothesis 2). The statistically insignificant CAR(-21,-140) coefficient supports

the expectation of no signaling effect for better future earnings due to the unique institutional

settings of the ISE (Hypothesis 2).

To control for the effect of having “capital gain reserves” as one of the capitalization

sources, the dummy variable DCGR is added to regression 1 and the results are presented in

regression 2 of Table 8. The coefficient is statistically insignificant indicating no effect

(Hypothesis 4). However, we should mention that the statistically insignificance of this

coefficient can be due to the fact that the event is contaminated with the effects of other

capitalization sources such as the inflation revaluation reserves.

6. Conclusions

We examine the market reaction to bonus issue announcements in a market setting

where the cash dividend substitution, agency cost, transaction effects and retained earnings

hypotheses are not prevalent and bonus issues are capitalized in the paid-in capital amount

mainly from equity reserves which are created due to the revaluation of assets in an

inflationary environment. We provide empirical evidence for the signaling, enhanced

liquidity and neglected firm hypotheses as well as for the importance of the amount of paid-in

capital in an inflationary environment.

We find that, on average, the abnormal returns are positive and significant on the

announcement day. We try to provide empirical evidence by relating the bonus distribution

ratio as well as the market reaction abnormal returns to the corporation’s stock liquidity, to

the neglected firm effect and to the signaling of future prospects hypotheses. In addition to

regression results, we use three liquidity measures, the change in the stock’s trading volume,

the change in relative trading volume, and the change in the market depth ratio in order to test

23
the enhanced liquidity hypothesis which states that stock distributions increase the number of

shares in circulation in a closely held market structure, and hence, increase the liquidity and

marketability of the stocks. Additionally, the motivation can also be to return the stock price

to a normal trading range, especially in a market where the stock market index has

continually increased significantly during the period of analysis. In the absence of agency

cost, cash substitution, transaction cost and retained earnings effects, the positive

announcement effect provides evidence for the enhanced liquidity expectation. The three

liquidity measures, namely the raw trading volume, the relative trading volume and the

market depth ratio, are significantly positive indicating that bonus issue distributions increase

the liquidity (market depth) of the stocks traded in the ISE. Especially, the improvement in

liquidity is stronger for distributions with relatively less liquid stocks. We also find that if the

stock’s liquidity is already high, the bonus issue distribution does not change the liquidity.

The result of no change in liquidity for stocks which are already highly liquid might reconcile

the mixed liquidity evidence of stock distributions in the U.S.. In a regression analysis

framework, bonus distribution ratio is related to the size of corporation as well as to the pre

bonus issue price level. The magnitude of market reaction is also explained by the pre bonus

isse price level as well as the size of bonus distribution ratio. In the ISE settings, bonus issues

are associated with an increase in liquidity and this empirical finding contributes to the

liquidity effect studies of stock distributions which have had mixed results in the U.S. and in

other developed capital markets.

Our univariate analysis of operating margin around the event year and the statistically

insignificant relationship between the market reaction abnormal returns and the pre bonus

issue stock price run up do not provide support for the signaling hypothesis which is expected

to less relevant given the ISE’s institutional settings where bonus issues are frequent and

emanate from an accounting treatment in an inflationary environment. Additionally,

24
corporations follow instable dividend policies in addition to the low cost of sending false

signals and neutral transaction cost effect. This result is consistent with the irrelevancy of

signaling hypothesis for better future performance in markets with similar institutional

settings such as Germany and Greece (Wulff, 2002; Papaioannou et al., 2002; Leledakis et

al., 2008). Additionally, the insignificant relationship between the market value of the

corporation and the magnitude of market reaction does not provide empirical evidence for the

neglected firm hypothesis.

Different from many of traditional studies in stock distributions, we also test for

differences in market reaction for bonus issues capitalized from different sources of equity

reserves. We detect some empirical evidence for difference in the magnitude of market

reaction, especially for announcements that include “capital gain equity reserves” which

provide some tax advantages for the corporation. However, the empirical evidence is not

strong due to the fact the announcements are contaminated with other sources of reserves and

we could not isolate the effect for the “capital gain equity reserves.”

The unique finding of the study is that the motivation of issuing bonus issues in a

market environment of limited access to external equity capital and high inflation is to

increase the amount of eroding paid-in capital for more credibility and borrowing capacity for

growth. Unlike the institutional settings in the U.S., the amount of paid-in capital has more

legal and corporate policy implications especially in countries where the continental

European law system is adopted such as Turkey, Denmark and Switzerland. In the

announcements of bonus issues by the Board of Directors, the increase in paid-in capital as a

result of the bonus issue is stressed. Within the institutional settings of high inflation, weak

shareholder and high creditor rights, closely held market structure, unavailable corporate

bond market, the increase in paid-in capital is welcomed by the ISE investors with a positive

25
market reaction. Empirically, we find a statistically strong positive relationship between the

size of the bonus distribution ratio and the debt to paid-in capital ratio.

26
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29
 120% 400%

350%
100%

300%

Avg. Bonus Distribution Ratio

80%
Consumer Price Inflation

250%

60% 200%

150%
40%

100%

20%
50%

0% 0%
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Consumer price inflation (%) Average % increase in paid-in capital by internal resources
Figure 1. Consumer Price Inflation, Average Paid-in Capital Increases by Bonus Issues
between January 1986 and December 2006
Return (%)

4.50%
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50% -5 -4 -3 -2 -1 0 1 2 3 4 5
-1.00%
Day
AR CAR
Figure 2. Market Reaction around Announcement Day 0

30
 Table 1. Descriptive Statistics for the Bonus Issues by Non-financial Corporations
This table reports selected descriptive statistics for 1,326 bonus issue distributions by non-financial corporations
traded in the Istanbul Stock Exchange over the time period 1986 to 2006. Bonus issue ratio is the amount of bonus
issues in New Turkish Lira (YTL) distributed as a percentage of paid-in capital. It should be noted that the bonus
issue ratio is also equivalent to the percentage increase in the number of shares outstanding. The Bonus Issue
Frequency Ratio is calculated using corporations with at least five years of trading and is calculated as the number
of bonus issues divided by the number of transaction years in the ISE.

Panel A. By Year and 1986-2006 Overall

Year Number of Distributions Average Bonus Issue Ratio Realized (%)
1986 22 64
1987 22 67
1988 28 69
1989 38 82
1990 50 89
1991 60 107
1992 59 95
1993 63 66
1994 93 112
1995 96 154
1996 96 141
1997 90 127
1998 84 166
1999 90 243
2000 82 345
2001 79 155
2002 73 319
2003 69 171
2004 68 271
2005 33 227
2006 31 114
1986-2006 Bonus Issue Ratio (%)
Average 166 Minimum 0.1
Median 75 Maximum 11,300

Panel B. Bonus Issue Frequency Ratio for Corps. with at least 5 Yrs. of Trading (N:224)
Bonus Issue
Frequency Ratio Number of
(Rounded to the nearest %) Corporations % of Bonus Issue Distributions
0% 4 2%
10% 10 4%
20% 32 14%
30% 59 26%
40% 47 21%
50% 37 17%
60% 15 7%
70% 10 4%
80% 8 4%
90% 2 1%
Average 40% Median 40%

31
 Table 2. Descriptive Statistics for the Bonus Issue Sample
This table shows the details of bonus issues and sources of the capitalization for the period between January 1995
and December 2006. “Inflation Revaluation Equity Reserves” include the revaluation fund reserve, cost
revaluation reserve and paid-in capital inflation adjustment reserve. “Other Equity Reserves” include equity
reserves such as share premium reserves and special reserves. “Capital Gain Equity Reserves” include the
reserves of capital gain from the sale of participation shares and capital gain from the sale of property. In 155 out
of 161 bonus issue announcements, the sources of capitalization are declared by the Board of Directors.

Panel A. Number of bonus issues sorted by capitalization source

Capitalization of
Combination of “Inf.
“Inflation Revaluation Equity “Capital Gain
Bonus Issue Revaluation Reserves” and Equity
Delivery Equity “Other Equity Reserves” and
Year Reserves” Only Reserves” all others Total
1995 4 2 2 8
1996 3 - 2 5
1997 4 3 2 5
1998 4 4 7 15
1999 5 7 10 22
2000 7 4 1 12
2001 13 5 3 21
2002 5 6 5 16
2003 14 4 5 23
2004 6 5 5 16
2005 3 - 1 4
2006 1 1 1 3
Count 69 (44%) 41 (26%) 45 (30%) 155 (100%)

Panel B. Sources of capitalization in New Turkish Lira (YTL) and % of total

Inflation
Other Equity Capital Gain Equity
Revaluation Equity
Reserves Reserves
Reserves
In YTL 1,808,878,2201 312,490,885 113,828,014
% of Total 81% 14% 5%

Panel C. Distribution of bonus issue ratio (%)

Bonus
1- 101- 201- 301- 401- 501- 701- 1,001-
issue Ratio >2,000
100 200 300 400 500 700 1,000 2,000
(%)
Number of
Bonus 74 44 18 10 4 3 4 1 3
issues
% of Total
46% 27% 11% 6% 2% 2% 2% 1% 2%
(N:161)
Average 277% Median 125%

32
 Table 3. Market Reaction to Bonus Issue Announcements
This table shows the daily mean abnormal returns (ARt) for the event window (-5 to + 5 around the
announcement day 0) and the cumulative abnormal return (CAR) for relevant periods, the percentage of positive
AR, and the parametric t-statistic values and the non-parametric generalized sign test values. The pre-event
period is defined as days -5 to -1; the on-event period is defined as days 0 and 1; and the post-event period is
defined as days +2 to +5. The sample size is 157 (4 outliers with bonus issue ratio greater than 1000% are
omitted). *significant at 1%; **significant at 5%.

Panel A. Daily abnormal returns

Period Dayt ARt %>0 t-value Gen. Sign. Test
-5 -0.0008 45% -0.26 -0.45
-4 -0.0035 45% -1.12 -0.29
Pre-event -3 0.0073 53% 2.32** 1.63
-2 0.0045 51% 1.45 1.15
-1 -0.0004 44% -0.13 -0.61
0 0.0179 59% 5.69* 3.07*
On Event
1 0.0100 55% 3.17* 2.27**
2 -0.0001 43% -0.04 -0.77
3 0.0045 47% 1.45 0.19
Post-event
4 -0.0025 39% -0.80 -1.25
5 0.0028 47% 0.92 0.19

Panel B. Cumulative abnormal returns

Period CAR t-value Gen. Sign. Test
Pre-event (-1, -5) 0.0072 1.02 1.15
On Event (0, 1) 0.0279 6.26* 4.52*
Post-event (2, 5) 0.0048 0.76 -0.92

33
 Table 4. Comparison of Bonus Issue Announcement Market Reactions: Event Window CAR (0, 1)
This table presents the cumulative abnormal returns categorized by the source of capitalization and show test results for differences in means and medians. Parametric Anova
F-statistic and nonparametric Kruskal-Wallis results are presented for testing the difference in mean/median among the three sources of capitalization. Similarly, t-test and
Mann-Whitney U-test results are presented for testing the difference in mean/median between the two sources of capitalization. *significant at 1%;**significant at 5%;
***significant at 10%. Numbers in parentheses denote medians.

Panel A. Comparison of all three sources of capitalization and equality tests

Event Window ANOVA Kruskal-
t-value Gen. Sign. Test
Capitalization Source CAR (0, 1) F-statistic Wallis
Inflation Revaluation Reserves Only (N: 69) 0.0292
3.59* 4.51*
(0.0231)
Combination of Inf. Rev. Reserves and Other Equity 0.0352
Reserves (N: 40) 4.20* 3.82* 0.68 2.21
(0.0221)
Capital Gain Equity Reserves and (Inf. Rev. Reserves 0.0165
2.19** 1.02
and/or Other Equity Reserves) (N: 43) (0.0002)

Panel B. Equality tests for different sources of capitalization

Capitalization t-test MW test
“Inflation Revaluation Equity Reserves Only (N: 69)” versus “Combination of Inf. Rev. Reserves and
Other Equity Reserves (N: 40)” 0.39 0.10

“(Inflation Revaluation Reserves Only + Combination of Inf. Rev. Reserves and Other Equity
Reserves (N: 109)” versus “Capital Gain Equity Reserves and (Inf. Rev. Reserves and/or Other 1.17 1.61***
Equity Reserves) (N: 43)”

34
 Table 5. Liquidity Analysis
This table shows three different measures of the change in the liquidity of 153 (decrease in sample size due to 4
outliers and lack of volume data for 4 observations) bonus issue announcements comparing the liquidity for the
period (-140 to -21) relative to the announcement date to the liquidity for the period (+21 to +140) relative to the
bonus issue delivery date/ex-day. The change in raw trading volume for security i is measured as ln(VOLi,after)-
ln(VOLi,before) where VOLi,after and VOLi,before are the average adjusted daily trading volume in lots. The change
in relative trading volume for security i is measured as ln(relVOLi,after)-ln(relVOLi,before) where relVOLi,after and
relVOLi,before are the average daily relative trading volume in lots. The daily relative trading volume in lots is
calculated by dividing the unadjusted trading volume by market volume for each day. The change in the market
depth ratio for security i is measured as ln(MDi,after)-ln(MDi,before) where the market depth (MD) is measured as
Σt(VOLi,t)/ Σt(|Ri,t|) where VOLi,t and |Ri,t| are the trading volume in lots and the absolute return respectively on
stock i on day t during the period before the announcement and after the ex-day. *significant at 1%;**significant
at 5%; ***significant at 10%.

Panel A. Raw trading volume

Paired Diff.
Lots of Pre Ann. Post Ex LN
Sorted tests %∆LN>0
Shares Period Period Diff.
Groups (p-value)
Mean 611,073 649,742 0.060 0.92
(Trimmed Mean) (450,275) (482,274) (0.065) (0.36)
ALL 53
5,769
Median 208,713 257,668 0.023
(0.35)

Mean 37,992 60,158 0.249 2.11**

(Trimmed Mean) (37,375) (54,308) (0.246) (0.04)
1-50 60
800***
Median 35,094 40,918 0.163
(0.06)

Mean 245,633 324,337 0.042 0.33

(Trimmed Mean) (241,004) (295,750) (0.073) (0.74)
51-100 54
695
Median 212,167 278,497 0.198
(0.42)

Mean 1,636,622 1,635,833 -0.146 -1.65***

(Trimmed Mean) (1,519,776) (1,472,452) (-0.156) (0.09)
101-153 40
364***
Median 1,073,805 1,179,106 -0.199
(0.08)

35
 Table 5 – Cont.
Panel B. Relative trading volume
Paired Diff.
Lots of Pre Ann. Post Ex LN
Sorted tests %∆LN>0
Shares Period Period Diff.
Groups (p-value)

Mean 0.0020 0.0028 0.557 6.66*

(Trimmed Mean) (0.0136) (0.0021) (0.546) (0.00)
ALL 69
9,118*
Median 0.0050 0.0010 0.388
(0.00)

Mean 0.0001 0.0005 1.065 6.60*

(Trimmed Mean) (0.0001) (0.0004) (1.080) (0.00)
1-50 76
1,137*
Median 0.0001 0.0004 1.306
(0.00)

Mean 0.0006 0.0015 0.547 4.25*

(Trimmed Mean) (0.0006) (0.0011) (0.543) (0.00)
51-100 78
1,042*
Median 0.0005 0.0009 0.560
(0.00)

Mean 0.0052 0.0062 0.086 0.78

(Trimmed Mean) (0.0043) (0.0057) (0.094) (0.44)
101-153 55
796
Median 0.0031 0.0036 0.039
(0.48)

Panel C. Market depth ratio

Paired
Lots of Pre Ann. Post Ex
Sorted LN Diff. Diff. tests %∆LN>0
Shares Period Period
Groups (p-value)
Mean 23,376,607 25,387,892 0.118 1,75***
(Trimmed
Mean) (17,502,888) (19,845,367) (0.123) (0.08)
ALL 56
6,280***
Median 8,553,726 10,540,896 0.119
(0.05)
Mean 1,294,330 2,515,784 0.349 2.59**
(Trimmed
Mean)
(1,277,271) (2,022,722) (0.348) (0.01)
1-50 61
819**
Median 1,119,669 1,396,164 0.457
(0.02)
Mean 9,537,646 12,561,903 0.054 0.46
(Trimmed
Mean)
(9,333,660) (11,496,362) (0.107) (0.64)
51-100 57
763
Median 8,713,959 11,147,299 0.182
(0.23)
Mean 60,651,017 62,391,310 -0.052 -0.61
(Trimmed
Mean)
(55,044,932) (58,187,983) (-0.065) (0.54)
101-153 48
509
Median 39,291,756 42,785,135 -0.011
(0.56)

36
 Table 6. Operating Margin and Financing Analysis
In this table, several financial ratios with sample averages and medians are calculated for the fiscal years ending before the event (t-1), the event year (t) and the year after the
event (t+1). Parametric t-test for the mean and the non-parametric Mann-Whitney U-test for the median are both used to detect the statistical significance of changes in mean
and median between the three periods ((t-1) to t);(t to (t+1));((t-1) to (t+1)). *significant at 1%;**significant at 5%; ***significant at 10%

Fiscal year relative to event year t Difference tests (t-test for mean; MW U-test for median)
t-1 t t+1 (t-1) to t t to (t+1) (t-1) to (t+1)
Operating Margin (%)
Mean 16.89 14.56 16.48 1.33 0.80 0.17
Median 16.07 14.86 14.21 1.16 0.15 0.96

Debt/Equity (%)
Mean 136.87 143.22 146.78 0.37 0.20 0.59
Median 96.93 94.17 106.11 0.03 0.04 0.04

Debt/Paid-in Capital (%)

Mean 656.05 334.06 442.13 4.36* 1.92*** 2.56**
Median 381.59 239.29 276.78 3.90* 1.39 2.61*

Short-term Debt/Total Debt (%)

Mean 74.79 72.83 70.82 0.95 0.90 1.87***
Median 77.47 75.36 74.94 0.44 0.85 1.63***

Debt Growth Rate (%)

Mean 60.94 63.40 49.55 0.29 1.57 1.45
Median 52.68 46.10 34.62 0.43 1.50 2.23**

Short-term Debt Growth Rate (%)

Mean 71.28 65.89 48.27 0.48 1.72* 2.34**
Median 55.43 41.84 29.20 1.07 1.11 2.35**

37
 Table 7. Determinants of the Bonus Issue Distribution Ratio
This table shows the regression results of the following model explaining the determinants of the bonus issue
distribution ratio. BDR is the bonus distribution ratio; P is the natural log of unadjusted stock price at the end of
quarter before the bonus issue announcement; MV is the natural log of market value of equity in US$ at the end
of quarter before the bonus issue announcement; DCP is the debt to paid-in capital ratio at the end of quarter
before the bonus issue announcement. In the following results, the upper value is the regression coefficient and
the lower value is the White heteroskedasticity-consistent t-statistic for that coefficient.
*significant at 1%;**significant at 5%; ***significant at 10%

BDRi = α0 + α1Pi + α2MVi + α3DCPi + εi

Debt to Paid-in
Intercept Stock Price Market Value
Capital
α0 α1 α2 α3 Adjusted R2 F-stat.
4.577 0.546 -0.259 0.097
40.37% 33.96*
(2.93)* (3.66)* (-2.84)* (4.11)*

38
 Table 8. Determinants of the Market Reaction
This table shows the regression results of the following model explaining the determinants of the market
reaction CAR(0,+1). BDR is the bonus distribution ratio; MV is the natural log of market value of equity in US$
at the end of quarter before the bonus issue announcement; P is the natural log of unadjusted stock price at the
end of quarter before the bonus issue announcement; CAR is the cumulative abnormal return for the period -21
to -140 relative the announcement day 0; DBON is a dummy variable having a value of 1 if the corporation does
not have a bonus issue in the previous year; DCGR is a dummy variable having a value of 1 if the bonus issue
announcement includes “capital gain reserves” as one of the sources of the capitalization. In the following
results, the upper value is the regression coefficient and the lower value is the White heteroskedasticity-
consistent t-statistic for that coefficient. *significant at 1%;**significant at 5%; ***significant at 10%

CAR(0,+1),i = α0 + α1BDRi + α2MVi + α1Pi + α4CAR(-21,-140),i + α5DBONi + α6DCGRi + εi

Capital
Bonus
Market Market CAR Bonus Gain
Inter Dist.
Value Price (-21, 140) Dummy Reserves
Ratio
Dummy
α0 α1 α2 α3 α4 Α5 α6 Adj. R2 F-stat.
0.026
(1) (0.42) 0.026 -0.001 -0.012 -0.015 -0.005 27.73% 12.21*
(4.80)* (-0.21) (-1.90)*** (-1.36) (-0.45)
(2) 0.025 0.026 -0.001 -0.012 -0.014 -0.004 0.004 27.28% 10.13*
(0.40) (4.74)* (-0.23) (-1.90)*** (-1.28) (-0.40) (0.36)

39
Notes:
1
See, for example, Grinblatt, Masulis, and Titman (1984) and Rankine and Stice (1997) for the US
evidence. Similar market reactions are also detected in other markets such as Australia, Canada,
China, Denmark, Germany, Greece, Hong Kong, India, Japan, Korea and Switzerland. (e.g.,
Balachandran et al., 2004; Kryzanoswki and Hao, 1991; Barnes and Ma, 2002; Bechmann and
Raaballe, 2007; Wulff, 2002; Leledakis et al., 2008 and Papaioannou et al., 2000; Wu and Chan,
1997; Lukose and Rao, 2002; Kato and Tsay, 2002; Dhatt et al., 1997; Kunz Rosa-Majhensek, 2007).
2
A similar corporate practice has been used in Greece due to high levels of inflation since the early
1970s (see Papaioannou et al., 2000).
3
Stock splits are allowed in Turkey, but since corporations typically issue their shares at the minimum
legally possible par value, corporations can not split stocks to a lower par value. In our study, we
could not detect any cases of stock splits during our sample period. Similar institutional settings such
as minimum mandatory par values for stocks are found in Switzerland (Kunz and Rosa-Majhensek,
2007) and Germany (Wulff, 2002) leading to stock splits whenever the minimum par value amount is
lowered.
4
The accounting treatment for large and small bonus issues is not different in the Istanbul Stock
Exchange as it is in the U.S. (see Rankine and Stice, 1997 for more details).
5
In this database (http://www.ise.org/company/capitaldividend.htm), since the establishment of ISE in
1986, for each year, the authorized capital of the corporation, the paid-in capital of the corporation
before and after the capital increase, the amount of bonus issues and stock dividends, and the stock
delivery dates are supplied along with other seasoned equity offerings data.
6
Similarly, the institutional settings in Germany and Greece limit the ability of companies to use
stock distributions for signaling (Wulff, 2002; Papaioannou et al., 2000; Leledakis et al., 2008). Wulff
(2002) and Papaioannou et al. (2000) find no support for the signaling hypothesis in Germany and
Greece.
7
As Kamiler (2006) shows, the direct costs of bonus issues such as approval fees and accounting fees
are low adding up to on average 0.5% of the amount of the issue. It is very rare that bonus issue
distribution decisions are made in an extraordinary shareholder meeting, typically a board of directors
decision is enough for implementing the bonus issue distribution.
8
Demirag and Serter (2003) show that the ownership of Turkish companies is highly concentrated,
families being the dominant shareholders.
9
Similarly, we find a mean short-term debt to total debt ratio of 75% for the period 1995-2006 in our
sample.

40
10
The uncontaminated bonus issue announcements include the board of director’s decision
announcements with no simultaneous corporation specific news such as rights offerings, earnings and
dividend announcements and with no official daily bulletin news around ±5 day around the
announcement day.
11
The official ISE daily bulletins published in 1995 and after are used as the mandatory information
disclosure requirements and standards have been introduced during the second half of 1994 by the
Capital Markets Board, the capital markets regulatory body.
12
It should be noted that bonus distribution ratio is also equivalent to the percentage increase in the
number of shares outstanding.
13
Two other models, namely the market model and mean adjusted model, are also used for measuring
the market reaction. The test results are quantitatively and qualitatively similar to those reported in the
paper. Additionally, none of the stocks in the sample has missing trading price data eliminating the
non-trading problem in event studies.
14
As Bechmann and Raaballe (2007) point out, stock dividends and stock splits are typically
implemented after a period of stock price increase leading to potential bias in using the pre-event
estimation period and they use a post-event estimation window. For our sample, the cumulative
abnormal return for the estimation period (-21,-140) is statistically insignificant and in the Turkish
setting, more biases will be introduced by using a post-estimation period due to possible effects of the
stock delivery (ex-day) which is on average 69 trading days apart for our bonus issue sample.
15
Similarly, Muradoglu and Aydogan (2003) do not use the volume turnover as an indicator for
liquidity since the average percentage of corporation equity open to public is 26% and the minimum
listing requirement by the ISE for free float is only 15% of outstanding shares.
16
Since corporations trading in the ISE distribute bonus issues frequently and in order to avoid the
confounding effect of another bonus issue in the previous and subsequent year, the liquidity measures
are computed for a limited time period of 120 trading days (±6 months).
17
Typically, studies on stock distributions use earnings per share and dividends per share as proxies
for the signaling hypothesis. Due to the inflation effect on the earnings figures and instable dividend
policy adopted by the ISE corporations, we do not use these two proxies and instead, some studies use
the operating margin as a proxy (e.g., Heron and Lie, 2004).

41