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THE JOURNAL OF FINANCE

* VOL. XXXIV, NO. 1 * MARCH 1979

**Liquidity Changes Following Stock Splits
**

THOMAS E. COPELAND*

I. Introduction

THERE HAS BEEN CONSIDERABLEempirical research on

the return behavior of

common stocks in calendar intervals surrounding stock splits. A partial list includes work by Barker [2]; Johnson [25]; Hausman, West and Largay [21]; Fama, Fisher, Jensen, and Roll [16]; and Bar-Yosef and Brown [1]. However, little or no evidence has been collected about stockholder trading behavior in split-up securities. This is surprising because it is often alleged that stocks split because they provide "better" markets for trading. This study presents evidence about the liquidity effects of stock splits. There are numerous rationales for stock splits, and many are related to the liquidity of trading. For example, one often hears on Wall Street that there is an "optimal" price range for securities. Stocks which trade in this range are presumed to have lower brokerage fees as a percent of value traded and therefore appear to be more liquid. This "optimal" range is considered to be a compromise between the desires of wealthy investors and institutions who will minimize brokerage costs if securities are high-priced, and the desires of small investors who will minimize odd-lot brokerage costs if securities are low-priced. Implicitly, there is a trade-off between diversification benefits and the lower transactions costs of round-lot trading.' One difficulty with the argument is that small investors can economize on odd-lots by forming investment clubs or by buying no-load mutual funds. A second difficulty is that odd-lot trades are simply not a significant fraction of trading activity. Finally, if the price of a security becomes "too high," the market obliges by making ten shares a round lot. Another explanation for splits, also heard on Wall Street, is that they create "wider" markets. Following a split, the number of shareholders may increase simply because an individual, who holds one round lot and who is likely to sell it to one buyer before a two-for-one split, may sell two round lots to two people after the split.2 If the number of shareholders increases after the split, then trading volume increases. Demsetz [11] shows that higher volume results in lower

* Assistant Professor of Financial Economics, The University of California at Los Angeles. I would like to express my gratitude to Harry DeAngelo, David Mayers, Vinay Marathe, Ron Masulis, Keitlv Smith, and Richard Roll for helpful comments on earlier drafts of this paper. Financial assistance was generously provided by the Cantor Fitzgerald Fund for Financial Research. Also I would like to thank Josephine Cheng and Tsutomu Nakamura for computer programming. All errors in the paper are, of course, solely my responsibility. ' For a good exposition of this point see Goldsmith [19]. 2 Barker [2] compared a sample of 90 companies whose stocks had split with an equal sample of nonsplit companies in the same industry groups. He found that between December 31, 1950 and December 31, 1953, the average gain in the number of shareholders for the split-up stocks was 30%as compared with 6% for the companies whose stocks had not split.

115

and transactions costs. then bid-ask spreads might increase rather than decrease. Any of these might change. we shall adopt Hicks [22. liquidity changes following stock splits is an empirical question. If the bill were generally acceptable as a medium of exchange or if transactions costs were zero.116 The Journal of Finance bid-ask spreads. Because there are good counterarguments for every argument in favor of higher liquidity in the post-split period. then the bill and money would be perfect substitutes. Part IV estimates the effect on brokerage revenues and bid-ask spreads as a percent of value traded in the postsplit market. it is possible to observe positive return residuals upon the announcement of a split even though investors anticipate lower post-split liquidity. the empirical results provide an estimate of the maximum length of time it takes new information to be completely incorporated into trading activity. there are parameters other than simply the number of shareholders which affect volume. The earliest model of volume developed by Beaver [5] was ad hoc and. as we shall show. and Roll [16] suggest that splits may be interpreted by investors as a favorable signal that the firm is able to maintain a new. Two measures of liquidity are used in this p'aper:1) changes in the proportional share volume of trading. The price of liquidity is the discount caused by the "trouble" of investing short-term bills which are not generally acceptable. Schwert . 163-170]. An Empirical Model of Volume If one wishes to test for changes in trading activity around an economic event. higher level of earnings. 9] and Epps [14] show that volume is determined by the rate of message arrival per unit time (also called information flow). For a definition of liquidity. For example. As a side issue. the percent of traders who view new information optimistically. Therefore. This would imply greater liquidity. Part V summarizes and concludes. and if the net effect is to reduce trading activity. the number of shares outstanding. A transactions cost must first be incurred in order to convert the bill into money for investment or consumption. This is because stock returns reflect only the net effect of splits. pp. Fama. Liquidity is the imperfect "moneyness" of very short-term bills. Models developed by Copeland [8. Fisher. Part III examines the stationarity of trading activity in the interval surrounding a split. If the benefit of the split message exceeds anticipated liquidity costs. it will be argued that permanent changes in 1) the volume of trading and 2) the transactions costs associated with trading can be unambiguously interpreted as liquidity effects. the total number of shareholders. it is desirable to construct a time-series model which is based on reasonable assumptions about the underlying causal factors and which has desirable distributional properties of residuals. return residuals will be useless for testing liquidity hypotheses. However. However. Part II of the paper develops an empirical model of trading in the jth security which is well-specified. More recently. Jensen. and 2) changes in transactions costs as a percent of value traded. We use these two measures rather than looking at return residuals because factors other than liquidity effects may coincide with a stock split announcement. H. misspecified.

assume that market volume in the tth time period. (E at) It = It. the weight in the last time period (and all following time periods) is set equal to zero. which will be determined by the data. Assume that It represents the total for unobservable information. Vmt = ) f (It. It_-2." winlbe estimated and used to calculate the number of time periods. at=a-bt. can be drawn from it. . 1 A reasonable question. It. .0.1. It. t=O (3) Also. Further." we have b =2_ a2 and N= 2. b.N. It is necessary to establish a model which allows estimation of the impact of information arrival on volume even though it is not possible to provide a metric .Stock Splits 117 [34] has used a fourth-order moving-average model with the rate of change in share volume as the dependent variable. i.. constrained to add to one (E at = 1). (5) 3By contrast. It-. It-. in order to constrain the weights to be positive. other than those revealed by patterns of residuals. It_n. (3). . aN= a-bN= O. it concerns the rate of change in volume which is hard to interpret. asks what weights should be applied to messages which arrived in past time intervals.a . t=O. and no inferences. Vmt. geometrically declining weights whose sum can be written as Lim(a+a2'+ n. "a. both written in terms of "a.+oo1- +a')= 1 1 a >1 for O<a<1 have a sum greater than 100%. Solving the system of equations (2). *** . for the message to have full impact. and (4) for the time interval. (2) The weights are constructed to add to one because it is reasonable to assume that only one hundred percent of the information's impact should be counted. While this model has distributional properties superior to the one developed below. N (a real number). and previously generated news. The finite time-series model developed here is based on assumptions about the effect of information arrival on trading volume and allows an estimate of the maximum time required for the full impact of a new message to be realized. (4) The value of the information impact in the first time period. impact of a message on aggregate market volume and is measured in millions of shares.is a function of current information arrival. N.3 The linear constraint is written as N N > at=1=(N+1)a-bE t=O t.. It-1.. at >. .e. assume that the full impact of a message on market volume is felt in a finite number of calendar intervals ini a set of linearly declining weights. First.. and the slope parameter.

thereby causing a misspecification problem which will bias . let i#j E aj= - a K 2ai 2a i. and a third componentwould be specific to the firm. anotherto industrynewsindependentof market news. we obtain Vjt = vmt-it ioi .One fractionwouldrelate the generalmarketinformation.2a1) aj(2 . It-.+ 2-aj Market volume is the sum of individual volumes Vmt Vjt- (8) By disaggregating the jth security.aj It_i + *. KlI -K2t2- (10) Beaver [5] uses a regression equation (with a constant term) which is analogous to the market model used for security returns. These are assumedto be constant over time.118 The Journal of Finance Also. aj. + . (11) By comparing (10) with (11).3a? is 2-a (9) In order to simplify.81downward. _____2a i+. We will refer to this as the volume market model (VMM) and write it as: + Vjt = -Cao /1 Vmt + Ejt. * are likely to be highly inversely correlated (because of their negative sign) with the independent variable. market volume can be written as a function of "a": vwt = a(2 .naj) Vjt= a.K. 2-ai ~= K2 and rewrite Vjtas V= Vmt. . one can argue that the omitted variables. 'This is a time-seriesmodel which assumes that other factors which affect volume are constant. assume that the adjustment coefficient for an individual security is a constant fraction. Vmtalt+~ 2-a aIt + + a(2 2 -a na)LnI (6) In order to look at trading in individual securities. It. "a.aIt - . 4A more complexmodel would assumethat volumein the j-th securityhas three components. Factorsother than marketnews might includethe numberof shareholders changesin the schedule or of transactionscosts.2 2ai fi i. ai-It- .j -ai - 3a. 2-ai I t2 2a .2a) It_. of the market adjustment coefficient. Vmt."4 Volume in the jth security can be written as:5 aj(2 .It + 2 .

Vmt-1. "a.It-.aIti1). and all covariances are positive. is uncorrelated with the independent variables in equation (12).It -It-. and there would be misspecification bias in FTSM.It . It) - aCOV(Vmt. It0)]. The omitted variables in FTSM are of the form a(It .Vmt)(It It-i - (I It- ] and if a = 1." and subtracting the result from (10). the coefficients of the dependent variables should be biased downward because the unobservable variables are subtracted in the FTSM and have positive covariance with Vmt. a random sample of 25 companies was taken from a complete list of all New York Stock Exchange companies which split between January 1. there would be no misspecification bias at all because AIt = It .It-. and less than or equal to one ( 1. It-1) = 0. 1963 and January 1. It. In order to compare the volume market model (VMM) with the finite timeseries model (FTSM).) = E[(It - it)2 (L- )(It-It_1) - VAR(It) - COV(It.aIt-i) = a[COV(Vmt. then COV(Vmt. and we have COV(Vmt. For example. "a.33). (C) the constant term should be negative since it is a proxy for the expected value of the unobservable variables (ao < 0). 1974.It . The result is an equation which allows estimation of the first-period adjustment coefficient and which has less specification bias. Therefore. "a.It-) = COV(Vmt.and Vjt-1. There are several testable implications of the FTSM which predict that: (a) the coefficient of Vmtshould be equal to one (31 = 1). To the extent that bias does exist. the bias approaches zero as the first-period adjustment coefficient." were equal to one.It-) > ?. the magnitude of the misspecification error will be aCOV(Vmt.82 = 18313 C 1). and Vjt-1should be equal and opposite in sign (-/32 = . then Vmt= It.It) - COV(Vmt. (b) the coefficients of Vmt-. Companies were excluded for the following reasons: if they split more than once during the period.82Vmt-1 + /83Vjt-1 + Ejt (13) If the first-period adjustment coefficient. In fact. COV(Vmt. and (d) there should be negative serial correlation in the residuals. if they were financial . (12) A regression equation used to estimate (12) is a finite-adjustment time-series model (FTSM): Vt= - ao + 81Vmt.Stock Splits 119 The model can be improved by multiplying Vjt-1by the adjustment coefficient. the transformation used to arrive at FTSM considerably reduces the misspecification bias caused by the fact that It is not observable. (15) Equation (15) is less than (14) if 0 < a < 1. (14) However.) = E[(Vmt.aVmt-i + aVjt-i - a(It - aIt-i) - K1(It- aIt-2) -K2(It-2 - aIt3)-* . Consequently. if "a" is less than one. vjt= Vmt ." approaches one.

and split dates is given in AppendixTable A1. sum of squared sum of squaredresidualsand the unconstrained Next. f13. At the 98%confidencelevel (t . Again. announcementdates.is not significantly different from one was run using the coefficient and standarderrorestimates providedby the FTSM. A list of the company names.82 = 33. split factors.the 98%confidencelimit is .6 Table 2 comparesthe volume market model (VMM).For 574 observations. Table 2 shows that it is less than zero in 14 out of 25 cases and that the average is less than zero. the null hypothesis could not be rejected in 17 out of 25 cases. using all 574 observations.247.8 Due to potential nonstationarities(which are demonstrated to exist later in the paper). sum 'The F-test is computedas follows:first. Table 1 shows the mean. the F-test was run separately on data up to 72 weeks before the split and on data from 72 weeks after the split to the end of the data. 7An attempt was made to use volume turnover instead of volume. For each sample company. Also. A second predictionof the FTSM is that -.the natural logarithm of the data was used for the FTSM. the FTSM model provides a better fit.811nVmt+ f82 (ln Vmttl -ln Vt-1) + EJt. the theory predicts negative serial correlation 6Pearson[32] has developedconfidencelimits to test for nonnormality based on skewness. 1972. However.25 for 1.weekly volume and the numberof tradingdays per week were collected from Standard and Poor's ISL manuals. and kurtosis for weekly volume divided by the split factor and the number of trading days per week.if the split was less than 1. variance. using the above "constrained" residualsfrom the FTSM (usingthe naturallogarithmof each variable). a. calculatea "constrained" of squaredresidualsfrom ln V1t= a + ./2 and /3. but it provided worse fits because the shares outstandingfor individualfirmswere availableonly quarterlyand because shares outstandingfor the entire NYSE were not availableat all. This propositionwas tested by using an F-test. skewness. Also aggregate market volume on the NYSE was compiled. the empirical FTSM model is reasonablyclose to its theoretical specification. even in logarithmicform there is significantpositive skewness in 16 out of 25 cases. 1964 or after January 1.A quicklook at the averagecoefficients presented at the bottom of Table 2 shows the predicted downwardbias in . the theoretical specificationpredicts that the intercept term.120 The Journal of Finance corporations. In only three of the 25 cases before the split and five of 25 after the split was there a significant difference between -. Finally. or if the split occurredeither before January 1. will be less than zero.calculatean F-ratio F where: n = the numberof constraints= 1 k = the numberof independentvariablesplus the constantterm = 4 T = the numberof observations SSR)/n (constrainedSSR .1 in the VMM.unconstrained (unconstrained SSR)/(T - k) .34).7 but how well does it stand up to the predictions about the sign and magnitudes of the coefficients and the negative serial correlationof the residuals? A two-tailed t-test with the null hypothesis that the coefficient of market volume.2. Because of the obvious nonnormality.and the finite time-series model (FTSM). By inspection.

03 4.58 27.36 .70 2.61 .31 3.01 4.67 3.24 .99 15.575.49 .04 .26 2.92 22.241.24 7.60 3.26 45.90 11.74 3.90 17.479.50 2.50 2.679.83 Skewness.76 167. Co.710.18 4.941.64 1.46 .93 .08 .12 2.38 .05 288.19 .80 702.663.25 2.97 2.03 79.53 .42 54.956.32 19.58 85.31 Skewness and Log 3.58 Variance .74 4.54 49.64 3.76 Variance. and .3116.07 -.06 4.95 29.26 20.45 7.11 .40 Row) .41 19.97 2.46 .47 1.79 .41 39.704.121.18 .26 15.96 .42 3.41 2.27 3.01 2.80 3.54 195.82 Mean 13.27 103.63 26.35 4.98 62.542.26 Variance .58501.20 7.00 Skewness Kurtosis 3.73 7.76 25.84 3.56 .29 9.35758.64 177.97 64.33 7.29 66.32 300.431.51 1.29 177.60 6. No.15 37.23 .79 4.58 21.59 1.833.23 1.67 12.52 3.41 .20 3.15 Volume (First .99 .32 .40741.2120.77 5.02 2.24 14.33 3.77 4.53 173.53 -.35149.42 -.69 3. Mean.096.Stock Splits 121 12 11 10 9 8 7 6 5 4 3 2 1 Co.81 1.81 Kurtosis Volume .67 39.10 .34 60.44 .49 4.21 .05 .87 .36 2.84 2.886.61 3.64 2.063.75 21.39 34.62 279.23 .09 4.41128.61 .40 18.73 133.98 Kurtosis 25 24 23 22 21 20 19 18 17 16 15 14 13 No.52 105.15 .80 3.49 7.701.3418.98 2.35 . for (Second Table 1 Average Row) Daily 278.00 5.08 .83 3.20 17.34401.90 2. .63 6.96 179.07 .17 14.38 5. 5.12 3.67 4.67187.46 1.40 Mean 65.72 .46 13.40 2.82 4.22 3.49 .45 4.23 6.221.06 .116.53 5.78 1.64 2.18 2.22 3.50 3.76 27.41 5.33 11.38 4.047.29 .45 2.384.99 48.66 1.746.48 5.4938.46 3.43 .69 .69 10.

25 9.23 -.67 -3.84 -.73 -.83 .32 .18 -.69 .16/1.82 -.27 -5.65 7.05 -7.11 .23 -.66 .15 50.2 .63 .74 .63 .08 2.46 -.62 1.9 .1 .60 17.6 .95 10.79 .40/2.77 10.70 -.73/2.20/2.22 -.84 -.58 -.37 -6.24 16.61 -8.20 45.67 22.84 5.8 .47 3.15 -8.06 -.96 130.70 .99 5.06 3.37 244.73 -1. where: fit = split factor for the jth security on the tth week.18 -10.91 10.27 152.34/2.35 4.54/0.29 48.79 -1.09 4.00 9.72 4.81 .33 13.20 230.90 -.34 -. dt = the number of trading days in the tth week.88 -.92 10.01/1.82 -4.59 .1 .7 .78 2.11 658.57 -11.53 -.44 4.64 -.90 4.94 -.07 -7.23 -.0488.24 326.62 .39 .62 -.41 1717.00 12.04/0.67 7.0 .60/2.19 -.85 .29 .84 -2.61 .71 17.58/2.29 -4.08/0.18/1.33 1.4 .76 .81 .59 .79 2.68 .00 21.69 -8.17/0.36 -1.07 -.99 238.15 11.0 .35 70.74 239.42 7.71 3.53 15.9 .79 .94 .07 7. .69/2.75 9.14 .27/2.50/2.28 120.8 In (Vmt/dt) + .97 5.25 10.02 -.69 214.68 171.1(fjt_j)(dt_j)].19/2.64 -.08 -.39 -6.4 .77 .64 5.61 14.65 10.3 .07 8.81 -.40/0.25 19.52/1.19 5.85 -.97 -.98 .22 492.38 .50 11.41/2.39 -2.33 11.04 F r2/DW -3.83 .87 .53 -.99 98.25 8.9 .09 .70 19.01/0.23 18.30 1.56 -.88 -6.46 1.83 -6.47 .25 12.20 .00 24.9 .33 -6.21 2.64 22.2 .65 7.72 -2.13 303.99 -1.41 .66/2.40 1.7 .67 9.75 10.63/2.27 8.794 -25.13 -8.49 -.63 .99 147.11 50.06 8.24 a VMM: The average difference between /82 and -.66 .33 -1.99 360.1 .46 1.18 -.68 .13 7.81 .06 8.72 -2.72 -4.75 10.05 -2.41 -.32 .24/2.36 1.17 4.06 97.40 .56/2.81 -3.00/0.50 23.17 127.83 in the FTSM equals -.09 -3.56 -8.00 -2.0 .44 .0 .9 .4 .16/1.41 3.53 .56/2.25 40.85 13.45 1.38 -4.664 -5.56/2.39 5.13 9.53 .3 .5 .47 .51 1.43 -.53/0.33 -3.22 105.04 .22 78.20 -1.8 .17 .45 .08 59.03/1.1 .84 .75 .56 -9.9 .05 3.26 1.60 -1.25 -2.35/0.43 -5.15 5.4 .84 -8.41 .43 -7.25/0.64 5.94 -5.99 -.24 t(a) 26.28/2.4 .67 .5 .32 36.75 .53 .55/2.35 -6.45/2.36/0.51 .82 In (Vmti/dti1) + /83 In [Vjt_.62 329.46 -5.60 3.74 -15.96 265.52 -2.76 .73 6.4 .53 25.71 -.50 .40 -1.13 .83 261.43 -1.18 4.0 .31 .31 .58 4.60 501.87 -2.28/1.27 72.50 -4.25/0.03 .06 -6.8 .44 418.35/1.93 -3.33 24.6 .53 -.70 .00 -5.75 648.17 5.47 .35 112.50 11.72 7.71 -3.54 .44/2.50 .33 611.53/2.64 -1.68 3.50 -8.40 -3.97 .09 -1.50 -2.46/0.15 128.51 .01/1.88 10.7 .Table 2 Comparison of Two-Volume Modelsa Co.31 5.31 1.33 14.08 385.75 .38 25.72 .42 6.45 -1.52 -.09 -4.54 1.56 245.06/1.4 .30 -4.21 .48 1.19 2.90/2.9 .25 .68 3.13 .0 .60 -1.8 .28 .45 1.32 8.85 .1 .303 .34/2.95 -.31 1.50 13.97 .6 .25 4.00 5.09 495.05 -1.08/0.8 .15 .00 .47/2.57 -4.75 12.50 22.75 -1.19 46.0 .16 313.99 7.14 -2.09 . In FTSM: In [Vjtl(fjt)(dt)]= a + .54 -3. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Ave /I t(/31) /3 t(33) /2 t(a2) a 31.25 25.10 222.37 .34 186.8 .65 4.23 1.97 -.84 -2.53 -3.06 22.21/2.7 .37 .46/1.17 -3.0 .3 .20 -2.6 . No.00 -2.33 .1 . In [Vjt/(f1t)(dt)] = a + /31 (Vmt/dt).21 215.50 3.2 .2 .22 .1 .533 43.12/0.

If nonstationarities exist and data before the split is pooled with data afterward. Although only eight out of 25 of the concurrent market volume coefficients were significantly different from their predicted value of one. In the next section. not particularly high for time series data. No evidence of heteroscedasticity was found. The larger standard errors for 82 account for its greater range. Multicollinearity was rejected because of 1) the large sample size. however. evidence of a downward bias caused by the omitted variable problem. "a. 5) the average partial correlation coefficient was . ln Vmt. indicates heteroscedasticity. This is true in all 25 cases.and ln Vmtl was only . Furthermore.07 and 1.75 weeks. The above tests lead to the conclusion that the empirical FTSM model fits its theoretical specification surprisingly well.9. because of the downward bias caused by the omitted variable problem. an average adjustment coefficient of . then residual analysis could be biased. Heteroscedasticity was tested by dividing the time-series data for each company into halves. The Effect of Stock Splits on Trading Volume There is reason to expect that there are nonstationarities in trading behavior such that the FTSM model must be estimated separately for the pre.43 for -f82. III. all but three were less than one. Causal factors might include differences in transactions costs as a percentage of the value of assets traded or an increase in the number of shareholders.664 implies 2." The estimates average . the coefficients of the lagged terms provide estimates of the first-period adjustment coefficient. Having compared the VMM and the FTSM.01 weeks.and postsplit data. while .93. we should consider the estimates of "a" to be lower bounds. it is clear that the latter provides a much better fit of the data and considerably reduces the bias caused by the omitted variable problem. 3) when ln Vmt-lwas omitted.31 and . Other possible difficulties with the FTSM model are multicollinearity and heteroscedasticity. Merton [29] has argued that new information arrival may be "lumpy" in the sense that there are short periods of rapid activity in a stock preceding a significant economic event followed by longer periods of relative quiescehee. However. the FTSM is used to perform residual analysis on volume before and after stock splits.664 and range between . which if shown to be significant.533 and . There is. 2) the simple r2 between the collinear variables.533 implies that the full impact of information is felt within 2. two to three weeks may be interpreted as the maximum time required for the full impact of a new message to be felt. Table 3 shows the result of using the FTSM on data up to 48 weeks before the split data and from 48 weeks . both 82 and 8 were significant in 21 out of 25 cases and finally. Using equation (5).Stock Splits 123 which occurs when the Durbin-Watson statistic is greater than two. The ratio of the sums of squared residuals from each half is an F-test. the adjusted r2 declined 18 out of 25 cases and did not change in the remaining 7. A second possible interpretation is that two to three weeks measures the average length of message activity. 4) even though multicollinearity biases the t-statistic downward. That is.87 for 83 and -.

81 5.28 -3.36 3.80 6.83 1.11 7.33.85 -4.44 3 = Weeks a + /81before In the Table Vmt /32 3 + Split 10.67 7.17 1.76 6.97 46.09 50.96 21.16 -2.91 3.29 -4.52 42.36 3.74 -3.32 -1.18 42.64.t-1 a + from -.031.90 -.17 11.12 -.91 -.01 .72 -2.39 -5.09 -.61. Separate +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 No.35 41.01 -4.52 -.15 35.921.21.51 -2.56 -.37.15 -10.124 The Journal of Finance 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Co.59.15 3.46 -2.79 -3.81 -.91.44 1.68 -6.61 37.03 .70 -.80 -.89 -2.29 4.44 -.36 -.64 -3.99-5.55 72.27.35 .66.96 -2.37.42 .55 5.55 -.27.74 -4.43 12.93 1.53.17 -.38 77.09 -5.22 -.48.31 -3.07 3.39 9.15 -.50 6.27 -.40 5. -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 .83.41 -.63 02 end Regressions of A) the up to Data 48 In Vft -2.83 3.44 2.92 -.33 58.25 4.29 .87 -4.40 3.32 51.21 .02 -.06 2.66 -.74-6.82 5.47 -2.67 -2.76 -3.08 54.25 3.091.16 109.50 10.60 -1.44 -5.22 .45.67 -2.01 1.66 5.65.71 16.10 -3.62 -2.74 -.91 lEjt2 187.17 -.34 -.85 -1.95 -3.21 -4.60 1.34.13 -4.31 .58 1.20 4.43 10.13 7.57 53.00 -1.41 -3.73 -.51.80 5.32 t(fi1) 3.52 -.60 4.20 4.35.34.60 5.83 10.54 .31.40 fI 1.11 -.95 6.53 4.83 5.63.37 Vjt-1 Weeks + Ejt after the Split to the No.35.40 t(3) In and B) Vm.53.54 -.29 4.71 9.41 47.68 -2.58 -.99 -2.72 3.13 1.65 1.60 .34 .85 2.81 1.99 -2.26 2.67 7.08 -1.29 18.32 t(fl2) .12 27.84 -.14 -.66 -.19 -.05 1.69 .31 1.59 -.21 -1.35.20 .81 103.88 /83 48 In t(a) -.20 .59 -3.61 . 253 246 245 235 228 227 207 187 182 181 137 131 130 125 80 223 230 231 241 248 249 269 289 294 295 339 345 346 351 396 Obs 119.09 -.75 98.20 -1.99.71 11.75 3.89 -.88 -.25.78 -3.40 5.22-2.43 25.34.68 2.33 20.50.95 -1.16 .00 7.08 1.54 .00 6.24.74 5.20 77.20 6.83 7.62 .50.88 -.58 -1.562.86 .25 -.51 70.63 -2.47 .16 -3.80 7.17 4.48 -.66.29 .01 30.41 -.60 -2.36 -7.33.58.66 -4.16.21 -1.00 -.37 -7.79 1.87 21.63 -1.75 -1.40 -10.48 -.82 35.44.44 3.52 79.51 1.18 -1.

36 -.52.55 6.84 .20 6.39.56 .46 2.42 -.87 -4.20 11.50 4.11 -.22-.42.14-2.63 .53 .93 -3.62 2.54 29.18.33 12.72.78 -.94 -2.46 .84 129 187 189 192 193 193 194 201 220 84 392 347 289 287 284 283 283 282 275 256 4.40 8.29 -.55 2.40 -2.28 3.11 -.77 -.64 -3.07 -4.41 29.05 -4.28 97.13 .94 38.64.28.31 -.56.00 18.57 .57 8.85 -.20 3.61 -1.46 22.56.44 1.53 2.751.43.06 -.21 7.39 -.65 29.08 -1.63 1.33 1.15 -.50 .54 53.00 2.64 -2.72 29.20 11.72 .67 2.93 79.85 3.56 .49 -.971.38 -5.48.04 2.32 .88.75 -1.89.24 4.41.73 -.81 -1.12 .Stock Splits 125 Ave 25 24 23 22 21 20 19 18 17 16 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 .12 -.60 10.17 13.60.59 -2.76 6.62 .25 -.38.05 4.631.57 6.15 -4.24 .13 -.22 3.61 26.19 -.94 2.661.24 3.32 -.19 -4.00 10.60.07 -3.72 -.73 35.86 -3.59 -.63 -4.30.51.68 -1.79 -.47 -.64 -2.66 88.49.32 26.79 4.11 10.33 -.94 -1.94 5.15 3.83.33 24.18 .00 -.48 27.61 -.65.25 7.40 -.25 72.451.29 9.62 5.19 -4.00 4.20 -3.43 -.54 -.58 2.84 -3.03 .65.67 3.14 -.12 -3.15 -.13 85.46 1.95 -4.15 -2.05 -2.83 5.33 -2.46 -2.89 4.50 7.12 -1.26 -.92 -.90 27.33 12.75 -.90 .00 -1.49.38.75 -2.38 -3.54 -1.91 22.32 5.

Let Q2 be the sum of squared residuals from the FTSM (using the natural logarithm of the variables) regressed on data up to n weeks (where n = 48) before the split and let Q3 be the sum of squared residuals from n weeks after the split to the end of the data. a runs test could not be used to let the data decide how large the interval before the split should be.T {Ofori=s+n. 48 weeks was selected as a "safe" interval which would exclude abnormal behavior caused by the split itself. 1 ln V._. . The Chow test can be used to test the null hypothesis that the before-split coefficients are not different from the after-split coefficients. Therefore.82 is approximately equal to the average f3. Also a > 0 and 82 < 0. Note.. F-tests were obtained for each of the following four null hypotheses: H(a): the intercept terms do not change. for 19 the coefficient of market volume increased. . and that the average Ih is close to one. T fori= s-n n = the number of weeks before or after the split s = split week T = end of data ..'0 It was used on time-series data for each company excluding +48 weeks around the split. see Chow [7] or Rao and Miller [33.lnVmt + /l2D. because of the slight negative serial correlation.-1 ln + Ejt where Di. ***.n .126 The Journal of Finance after the split to the end of the sample. H(f8i): 8i does not change (i = 1. * f1 for i= s +n. *. we looked at patterns of cumulative average residuals for various intervals.. "'A brief description follows.. 2.s. However. Deviations from a random walk do not appear until around 35 weeks before the split.. + . 148-152] for a detailed description. however..9 For 21 of the 25 companies. pool the data from the two separate regressions and run the following equation. pp.= = where D {= D2 for i= 1. and for 17 the coefficient of lagged volume for the jth company decreased. + D2. 1. ln Vmt-i + (/2D2. that the average -.t-I + IVt-i 3. Next. however.1 ln Vmt-i + /33Di..B.. the intercept term decreased after the split. These are shown in Figure 1. 3). ln Vt = Di. This suggests that nonstationarity in the volume relationship follows the split. The results are summarized below: Summary of Chow F-Test Number of Significant Changes Positive Negative Total a 1 10 11 /I /2 /3 7 0 7 0 2 2 2 5 7 'The choice of 48 weeks was not completely arbitrary. Instead. . These are al conditions predicted by the theoretical specification of the FTSM.

to apply to the entire period set of data. (16) The average and cumulative average residuals are defined respectively as12 1 ARt T . the residual analysis was run using the FFJR technique of pooling data before and after the event and using the estimated coefficients to predict volume ?72 weeks around the split. Evidence of nonstationarity precluded use of pooling data before the split with data afterward which was the technique used in FFJR [16].B. The sum of squared residuals from the above equation is Ql. a random pattern in the cumulative average residuals would imply that splits have no effect on trading behavior. Ejt= ln Vjt-ln 25 Vjt. The result for normalized cumulative average residuals is shown in Appendix Figure A-1. t=1 Since the volume data have been adjusted by the split factor and because the residual analysis is centered around the split data. it is inconclusive. -48. The F-test is F= (Q2 + Q3)/(m+ QlQ-(Q2+Q3)/1 n-2k) where: m + n = the total number of observations = 476 and k = 4. and all seven significant changes in Ih (the coefficient of market volume) were increases. 12 The same procedure was duplicated using normalized cumulative average residuals instead of cumulative average residuals. This. The evidence in Figure 1 is quite clear. n. the evidence does suggest that stock splits result in nonstationarities in trading behavior. and -72 weeks before the split. and while the evidence suggests that the coefficient of lagged individual security volume decreases. is incorrect. Post-split volume is proportionately The procedure is equivalent to constraining .. but the pattern of residuals was unaffected. Ejt. (17) (18) CARt= E ARt.for the jth company in the tth week is the difference between the actual volume and the predicted volume which are both adjusted by the number of trading days per week and the stock split factor. the residual analysis was conducted by regressing the FTSM model on data up to -n weeks before the split date. " For the sake of curiosity. *. The residual.11 Figure 1 shows the plots of cumulative average residuals against time for the FTSM model fit on data up to -24. Evidence for nonstationarity in the relationship with lagged market volume was nonexistent. .E 25 j=1 Ejt. Although it is not possible to draw strong conclusions from the results of equations run on weekly data for 25 companies. the conclusion would have been that volume rises before the split and falls afterward. of course. Normalized residuals are obtained by dividing the residual by the standard error of estimate from the FTSM equation used to predict the dependent variable. The effect was that the scale of the changes became exaggerated. 4) degrees of freedom]. the intercept term decreased in ten out of the eleven cases where there was a significant change. Had nonstationarities not been accounted for. t= 1. Therefore.Stock Splits 127 At the 95% confidence level [for (476.

128 The Journal of Finance 'O -'6 .4M)Ovs \ Figure 1. trading activity decreases somewhat in anticipation of the split. There is also evidence that volume begins to decrease before the split. it is prudent to refrain from drawing any strong conclusions from the pattern of residuals immediately prior to the split date. However.o A. it is more difficult to interpret pre-split evidence for two reasons.65 weeks with the earliest announcement date falling 25. However.0r \ \ *~72WUEEEKS IL. . as shown in appendix Table A-1.40 -40 -to to 20 50 42 L *7Q2l ?S3 21 WEEKI . the announcement date precedes the split date by an average of 12. -'.5 weeks before its split. ?48. we cannot determine at what point the pattern of residuals significantly departs from its pre-split distribution. . Apparently. Model) Cumulative average residuals +24. and ?72 weeks around the split date (FTSM lower after a split as indicated by continuing negative residuals. First. Second.

We assume that each trade involves a 200-share block. average weekly price levels and knowledge of the transactions cost table. From April 6. The computation for multiple round lots was somewhat different and can be found at the bottom of Table A-2.00 per round lot. During each.g. brokerage schedules were fixed for small investors. an SEC fee. Table A-2 contains the appropriate rates for all taxes. The remaining 100 shares pays a round-trip commission of [$22 = .Stock Splits IV.13 Weekly brokerage fees and taxes paid in a round-trip transaction were simulated from weekly volume data. The New York state tax had two eras: 1963 to July 1.009(3.009($7. 1975. If brokerage revenues and bid-ask spreads increase as a percentage of value traded. Of the three transactions costs eras. whichever was less.25.719. 1972. and federal taxes.80. Both buyer and seller paid brokerage commissions while. The Effect of Stock Splits on Brokerage Bid-Ask Spreads Revenues and 129 As noted in the introduction..80 on the multiple lot order plus $6.045. The amount was $15 or 50% of the commission. then the one-way brokerage commission is $22 + .00.40. 1966 and July 1. 1966. This brings the total transactions costs to $21.550. 1970 until March 24.200.200) = $86.00 and SEC fees of $15. Total round-trip brokerage commissions on 104 two hundred share lots are $20. there are New York state taxes of $1. . the coefficients in Table A-2 labeled Al and Bi were applicable. when fixed commission rates were abandoned. 1972 until May 1. Appendix Table A-2 summarizes the transactions costs. there was a surcharge added to the commission from the rate schedule. 1975. By using historic price and volume data in conjunction with published brokerage rates. Suppose we are dealing with a $36. Finally. and transactions costs). the commission is calculated by means of a simple linear formula: Commission = B + A (Price). an SEC fee. In addition to the brokerage costs.659. the number of shareholders. From the beginning of 1963 until April 6. there were actually three different commission eras. proportionately lower volume following a stock split is consistent with decreased liquidity but is not conclusive because other parameters may affect volume (e.900 shares.20. total brokerage commissions for a 20. in addition. The simulation was necessary because the only way to reproduce actual transactions costs is to have continuous transactions data for each stock and to have complete knowledge of the various mechanisms used to avoid scheduled transactions costs. only the last is sufficiently complex to require explanation. the rate of message arrival.600)] = $108. the seller pays New York state taxes. therefore the amount of money involved in the order is $7.00 stock which has undergone a two-for-one split. The federal tax was levied from 1963 to January 1. This section of the paper focuses directly on transactions costs.05. 1966 to May 1. and federal taxes. Therefore. Examples of such mechanisms were give-up 13 Between 1963 and 1975. the coefficients labeled A2 and B2 were used for single round lots. from March 24. In addition to brokerage commissions. one can simulate the probable effect of stock splits on transactions costs paid by individuals to brokerage houses. 1970. During the sample time period. we will have further evidence of liquidity decreases in the post-split period. the seller paid New York state transfer taxes. The SEC fee is a trivial percentage of the transactions cost. If volume is 20.900 share-day are $20.

There is no doubt that the index overestimates the level of actual transactions costs. t_1 + Ejt. Figure 2 shows cumulative average residuals from values predicted by equations using only data up to n weeks before the split. although it has no theoretical specification per se. Ejt. Note that 521 weekly observations of transactions costs were available for each security. all trades were assumed to be 100-share round lots. for our purposes. Tjt. Table 4 shows the results of regressions using data up to 48 weeks before the split and using data from 48 weeks after the split to the end. 14 Alfred E. Before splits. it is possible only to simulate the approximate pattern of brokerage commissions and taxes paid by individual investors who presumably would not escape paying scheduled transactions costs. ." "institutional membership." and "fourway tickets. 1971). it is only necessary to argue that the changes in the level from week to week are highly correlated with the "true" index of transactions costs. For each trading week." Apparently between 40 and 80 percent of the supposedly fixed commissions were remitted to insitutional traders in the late 1960's.130 The Journal of Finance arrangements.14Therefore. none is needed so long as the usual OLS assumptions are reasonably well approximated. Kahn. (19) The above model is used only for the purpose of obtaining the pattern of transactions costs residuals. transactions costs and taxes were simulated by using the average weekly price and volume. The Economics of Regulation: Institutional Issues (New York: Wiley. p. while trading volume increases less than proportionately (a result which has been inferred from the continuing negative residuals in Figure 1) transactions costs increase more than proportionately because residuals are positive following the split. However. 1 The pattern of the residual analysis remained unchanged when the sample included only the 19 companies which split two-for-one. However. 196. The regression equation is ln Tjt = a + 81 ln Tnt + 82 ln Tmt_ + 83 In T.Therefore. A residual analysis similar to that which was used to investigate the effect of splits on trading volume is applied to simulated transactions costs. "regular-way reciprocity. and after the split the assumed number of round lots per trade were: Before 100 Shares 100 Shares 100 Shares 10 Shares 100 Shares No. Both show that on average the reaction to the anticipated split begins at approximately the 35th week before the split.15 Figure 2 can be compared to Figure 1. of Companies 19 2 2 1 1 Split Factor 2 for 1 3 for 1 2-1/2 1 for 10 for 1 1-? /2for 1 After 200 Shares 300 Shares 300 Shares 100 Shares 200 Shares A transactions cost index for the New York Stock Exchange was computed by assuming that the entire market volume was traded in 100-share lots at the average price of the Dow Jones Industrials.

a 16 The SEC fee as a percentage of transactions costs is trivial and can be ignored. However. then it appears that brokerage industry revenue changes exceed cost changes following stock splits. the ratio of the residual transactions costs to the predicted level of transactions was computed. This is true in spite of the earlier results which showed that proportional volume decreased. represent about 5 percent of operating costs" (Weinberg et al. Consequently. . In order to test this proposition. 18 Demsetz [11] provides a clear definition of transactions costs on the NYSE. along with Figures 2 and 3 leads to the result that post-split brokerage revenues paid by individual traders increased in the post-split period. The range was from -2. The average of the medians across all time periods was 7. From the split date until 72 weeks afterward. If this is true.1%. there is reason to believe that the median may be a better measure of location..16 The range was from -20. New York state taxes are never more than 6.000. Papers by Demsetz [11].30% (7th week).. Percent residual = E jj Pit 1. and the New York State Transfer Tax as a percentage of transactions costs for a round-trip transaction. the fact that volume increases less than proportionately would imply higher bid-ask spreads in the post-split era. "On the NYSE two elements comprise almost all of transaction cost-brokerage fees and bid-ask spreads. brokerage revenues increased by at least 7.92%increase in transactions costs is attributable to increased brokerage revenues. If the latter two variables are unaffected by splits. Then the mean and median percent residuals were calculated across all 25 sample companies in a given time period. the equation uses transactions data rather than its logarithmic transformation. This is $20.Stock Splits 131 In order to estimate the magnitude of the residual transactions costs following a split. 17 If accurate cost data for clearing and depository expenses of brokerage houses were available. Tinic [36]. Figure 3 plots the cumulative average residuals." The bid-ask spread is the transactions cost which is paid for predictable immediacy of exchange in organized markets.47% (49th week).51%. at least 90 percent of the observed 7.92%. Across all time periods. This evidence. because of skewness in the residuals.. Transfer taxes could [also] be included. it might be possible to estimate the effect of stock splits on brokerage industry profitability at the margin.528 per week per stock.99% (43rd week following the split) to 94. the increase in cumulative average residuals is $1. For the split week and each of the following 72 weeks.25% of the total cost.478. Figure 4 shows transactions costs as a percent of the value of a round block.58% (51st week) to 56."7 The second major transactions cost is the bid-ask spread. Then one might speculate on the motivation of the brokerage industry with regard to stock splits..."8Unfortunately. residuals were calculated using parameter estimates based on regressions which used data up to 72 weeks before the split. The only statement we could find was that "Clearing charges and related depository charges . the average increase in transactions costs was 27. the bid-ask spreads for the sample of NYSE stocks used in the study were never recorded. 25. and Benston and Hagerman [6] show that the bid-ask spread as a percentage of value is inversely correlated with volume and the number of competing dealers. Although Garbade and Silber [19] show that the expected liquidity cost may not equal the bid-ask spread in markets where there are competing specialists. we assume that the bid-ask spread is monotonically related to the liquidity cost. and positively correlated with price variance. E]t = Tjt- &- 1Tmt - I2 Tmt-_ - i3 Tjt-i (20) In order to obtain dollar residuals. West and Tinic [38]. [37]). In other words.

50 -.35.73 4.48 6.64 7.64 -1.52/2.13 .37.71 -1.08 .96 4.08 -.41 Weeks + Ejt after the Split to the .12 -.64 .43 2.01 .84 t(/2) -3.50/2.28 .59 .47 /3 Tit + /?2 Split 2.10 .30/2.32 P3i 1.44 -1.50/2.97 7.44.52 4.14 -.26.14 .721.54 -.04 .05/1.01 + from /83 In 48 .67 -4.64.26.41 1.31.30 .39 -.87.96.09 '.54 1.78 -6.92 -1.57 5.26/2.71 3.78 5.28 -.01-.60 6.50 3.29 .28 -2.27 1.91 2.04 3.64 7.42 2.35.16/2.33/2.28.30 .65.56 -.132 The Journal of Finance 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Co.22 1.45 .53 -.32/2.26 .34 -1.48.21.29/1.43 -.09 .06 1.03 .67 .55 -3.99 3.29 -3.15 .49 -2.07 4.71.57 -.27 -4.08 5.12 .35 5.86.17 .67 -6.64 5.72 5.17 .25 8.35.61 .71 .07 .15 .69 -.881.59.02 2.70.58.27 .23/2.80 1.34 -.76 5.92 .32 2.74 In and B) Tit-i a 3.t-i 2.77 .93 -2.971.67 1.44 -6.11 .87 -.16 .64.92 .45/2.22-2.35 -.35 -.07-2.05 -1.11 .08 3.27 3.38 13.12 12.36 2.09 .34 + before theTable 4 In .09 8. -48+48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 No.25 .62.29 .99 .51 -1.07 .81 7.76 2.18 -4.24 -4.21 -.85 3.03 4.31 .61/2.21.14 -. -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 Separate end of Regressions A) the 5.66 -3.03-.085.75/2.87 7.08 .15/2.93 10.54 2.23 3.01 6.75 11. 1.35 -.03 2.14 1.43.04 6.26 .38 3.73/2.75 5.30/2.38/2.19 Tjt = Weeks a -2.81 5.06 3.054.56/2.45 -.25/2.08 .87 -2.87 5.27 1.24 .39 5.39/2.88 2.93 3.49 13.68 -.29 -2.64.95 -2.35 7.00 .35/2.72 -.96 .85.13 .25/2.27.721.23/1.24 2.09 r2/DW 171 178 179 189 179 197 217 237 242 243 287 293 294 299 344 obs 254 247 246 236 229 228 208 188 183 182 138 132 131 126 81 .99 .07 3.59 3.67 -.41 .50 -.30 6.11 .70.31 -.53.41 5.51 7.48 .83 -3.59/2.63 7.38 7.23.97.10 .30.85 7.90 14.34.79 -2.06 -2.48 .67 -.25/2.44/2.24 26.89 .54.38 .83 6.98 -.17 1.37 6.64 .30 -.20 .40 .13 to Data 48 In /2 -.32 t(/31) up 5.31 t(/3) 9.81 1.68t(a) Th.04 -.03 9.54 1.95 6.10 .00 .49.81/2.46 .39 4.20 -.14 .141.03 4.38 3.14 4.39/2.38 5.54 4.26 -2.74 2.57/2.24 4.76 1.84 5.16.42.

52 1.02 .59 6.90.10 .71 5.46 3.48.65/2.06 -5.71 .06 .801.46 -.20 32 393 348 290 288 285 284 284 283 276 257 77 135 137 140 141 141 142 149 168 .17 4.22 .64 -.31 10.61 .28 .09/2.71/2.65 1.32 -.34 6.29 5.55 18.24 10.51 -.85 -.63 11.19 6.54 .02 -3.56 -2.24 .60.44.84.38/2.13 1.68.03 5.64 8.70 7.41 -.60 4.07 .67.55 -4.53 -4.54 -.55 -.36.78 1.39/2.25 -5.02 -1.08 -1.10 .06 .31 -.93.48.60 2.62 .73 4.86.32 5.921.51 7.03 2.19 -1.99 -.70.16 .17 .03 4.93 .75 6.54.42/2.94 2.33.03 .26 6.25 1.16 .04 .52 2.49 -.78 .78 .48 7.981.69 1.82 3.48 6.40.31 9.68 -2.06 .01 4.45 7.22 .53 -.91 .12 -.17 10.61.89 4.32 -.25 1.38/2.03 2.21 2.45/2.831.86 -1.15 -1.41/2.09 3.56 5.20 .43 -.02 5.821.03 1.81 2.73 -3.72 .10 .49/2.54.65 -.24 -.23 10.92 1.28.63/2.22 5.27 6.14/2.96 1.83 12.33 .44.19 -.33.90 12.68 -.52 .55 -.14 .61/2.71 1.04 .88 4.56 6.76 -4.75 8.62 .65 .86 3.43/2.84 -.19 .621.29/2.44 2.39 5.54 3.59/1.48 -.87 5.98 2.67 4.58 -3.08 3.74.30 -.13.53.78.32/2.19.76 8.57/2.89.07 5.21 2.30 7.26 -.22/2.09 .98 3.11 -.09 -1.33/2.15 8.39.74.30 4.93.39.87 -3.Stock Splits 133 Ave 25 24 23 22 21 20 19 18 17 16 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48 -48+48 +48 +48 +48 +48 +48 +48 +48 +48 +48 +48 .83 -.

0 7. A small-sample one-tailed t-test for the difference in means iS also presentea in Table 5. In each of three comparisons.0 _i.0%.95% to 6. The bid-ask spread increased as a percentage of the bid price in 89.19 Although significant positive skewness in the observations biases the '9 The t-test used was the small sample t-test where t = Al/2 A2'22 Vni n2 . twenty.54% twenty days afterward. 20.134 The Journal of Finance 8. and from 4.b~OO~O-o - io -50 '0 /t 50 607q 0S Figure 2. and 74.85% of the bid price one day before the split to 7. from 4.0 K72 LJEEKS 510 L1. +48.03% one day afterward.79% in the forty trading-day interval. the bid-ask spread as a percentage of the bid price on -n trading days before the split was compared with the same statistic +n days after the split (where n = 1. The sample was stratified to select five splits from each quarter. 79.73% twenty trading days before to 6. 40).34% of the paired observations for one. and +72 weeks around the split date random sample of 162 stock splits of OTC stocks between 1968 and 1976 was collected. and forty days respectively.5%. Also the average bid-ask spread increased from 4. Cumulative average residuals of brokerage revenues and taxes ?24. Table 5 summarizes the results. and if there were fewer than five splits in a given quarter. the sample in that quarter was exhaustive.

which is not biased by the skewness in the observed bid-ask spreads. A nonparametric signs test. the likelihood of observing the results is less than 5%. shows that in 17 out of the 23 within-years' comparisons. 275-279) is computed as follows: ( df= (2)2 2 A 2 2 cni n2 2 ( 2)2 ni+1 n2+ 1 . Cumulativeaverage(dollar)brokerage date t-test downward for observations within a given year.tO -1 e 1 s0 sio s0 60 T0 revenuesand taxes ?72 weeks aroundthe split Figure 3.5 4611 41 . pp.. the pooled data (across all years) have less bias and show significant differences at the 5% confidence level for each of the three comparisons.5o .40-t 40 40 .Stock Splits Millions of $ 135 1. a = sample variance n = number of observations A= sample mean The adjusted degrees of freedom (see Hoel [23].

19/36a 1.89 7.01 ?20 Percentage of Before.08/21a . 6.54 13.000 . Bid-Ask the + After Bid Bid 5.98.17/35 2.001 .50 6.46.18/22 1.11.15/119a 3.136 The Journal of Finance b a 1975 1973 1971 1969 Pooled1976 1974 1972 1970 1968Year Normal data: Significant ?1 2/20 2/20 2/18 3/20 1/20 0/11 2/20 2/13 3/20 at 17/162 decreases 5% For m out of N Approximation 0/11 2/18 4/13 6.56 5.96 ?40 Price ?1 1.64.34 3.019 - ?1 One Tail Bid Ask \ +20 / N q - ?40 Probabilityb Binomial pxqN-xwhere p = q = .66.75.59 3.132 .79 13.94.240 .004 . 4.33a to 5.26 10.000 .039.55/38 1.37/33 t-test/Adjusted Df.004 .133 .13 5. under the null 5.24/20 2. 2.34. 3. this is x=o ?1 ?40 ?20 +20 Decreased Number of Spreads ?40 Binomial - 29/113 0/11 3/18 2/12 7/18 3/20 8/17 6/17 Probability - .85. hypothesis.50. 2.04 3.24 5.252 .000 . observations. 3.3.45/342.36 5. 4.27.24/161a T-test/DF 8.30 6.34. 4.75/31 1. 5.79/40 1.5 6.51/27 2.14. 4.81.19 6.58 4. 4. 4.002 . 5.80.49/352. 2. 2.95 3.64.174 .25/22a 1.52. 3. - .80 6. ?1 Spreads as a Table 5 14.94.55. 4.001 .19/35.000 .85 3.68 9. 9.95.000 .002 .000 .74/352.69 Avg.500 .44. 4.001 . 1. 3.000 . 2.91 7.98/32 .002 .45.59/32a 1. 10.17a 10.54/16a 1.67.011 .06a 25/118 3/18 2/20 7/18 7/20 confidence level.08/32a .?20 1.62.97/113a 2.73.43/40 - .61/28 .?40 1.00 3.46.38 5.78/37 1. 9.22/38 .

<~ '~~~~ A 'V - -- 2 '3 t 2 3 4 to to 30 10 SO Price Per Share Figure 4. Transactionscosts on a round-triptransaction 1. When tested on approximately 11 years of weekly volume data for a random sample7of 25 NYSE companies whose stocks had split. can be rejected in every case. NYS Tax as of %of transactionscost 1/1/66 2. Conclusion A finite time-series model (FTSM) of trading volume for individual securities was developed from the assumption that trading during the current time period depends on messages arriving during the current and recent calendar intervals. Although the evidence is limited by the lack of extensive time-series data. Transactionscost 1/1/66 A normal approximation to the binomial for the pooled data shows that the null hypothesis. This is consistent with proportionately lower volume and higher brokerage revenues. cross-section comparisons at levels +1. that the pre-split and post-split distributions are identical. NYS Tax as of %of transactionscost 1/1/73 3. Transactionscost 1/1/73 4. After the FTSM model was . V.Stock Splits % of 100 Share Block Value 137 6~~~I . 20 and 40 trading days from the split date suggest that there are statistically significant increases in the bid-ask spread as a percent of the bid price and that the increase persists (up to at least two months following the split). the FTSM model proved to be superior to the volume market model (VMM).

One can argue that benefits may exist from splitting which equal or exceed the liquidity costs documented here. they will not inflict net losses upon themselves.138 The Journal of Finance shown to satisfy the properties expected from its theoretical specification. splits may have a value as messages which forecast anticipated dividend increases. it was used to estimate the speed of adjustment to new information. This directly contradicts the hypothesis that splits are motivated by a desire for "wider" or more liquid markets. it is interesting (but not necessarily germane) to speculate why liquidity is relatively lower following a split. and (3) patterns of brokerage cost residuals which are similar to volume in the pre-split period. Results show that brokerage revenues increased by at least 7. 20 and 40 days before a two-for-one stock split and compared with the post-split spreads. Finally. Finally. However.1% following splits. These results would not obtain if abnormal liquidity were a temporary phenomenon confined to a short interval around the split date. and (b) volume increases less than proportionately after stock splits. For example. brokerage -commissions and taxes paid by small investors were simulated for actualtrading behavior. these remain open questions in the interesting problem of why stocks split. Another possibility is that the portion of volume motivated by portfolio rebalancing may decrease after the split because individuals may buy and sell proportionately fewer shares after the split in order to achieve desired portfolio weights. If liquidity is relatively lower in the post-split era. However. but move in the opposite direction during the postsplit period. these results lead to the conclusion that there is a permanent decrease in relative liquidity following the split. Next. namely normal pre-split liquidity followed by abnormally low post-split liquidity. One possibility is that the rate of information arrival is higher before the split because companies which decide to split were doing comparatively well relative to the market. Lower post-split rates of information arrival might imply lower volume. (2) patterns of volume residuals which do not change as the pre-split interval is increased from 24 to 72 weeks. it is somewhat cheaper to diversify after a split because smaller values can be traded at round-lot transactions costs. it is not possible to conclude from the results of this study that they do. One hundred percent of the response of volume to new information took place in less than two to three weeks. Evidence for a permanent rather than a temporary effect consists of three results: (1) Chow tests which show significant differences between pre. That brokerage fees and bid-ask spreads are higher after splits is consistent with abnormally favorable pre-split liquidity followed by normal post-split liquidity or the opposite. However. a sample of 162 OCT bid-ask spreads were collected for 1. The results showed that post-split bid-ask spreads increase significantly as a percentage of the value of the stock. Taken together. The FTSM model was then used to show that (a) nonstationarities in trading behavior follow stock splits. why do shareholders agree to splits? Surely. . Also.and post-split relationships. either way shareholders may interpret a split as a message of relatively lower liquidity following the split event.

00 24.71 2. Distillers Goodyear Ntl. 8. 25.14 12. 15. Cumulative average residuals ?72 weeks around the split date using the FTSM model and the FFJR technique which pools data before and after the split Appendix Table A-1 25 Sample Companies Date of: Split Factor 10 for 1 2 for 1 2 for 1 2 for 1 5 for 2 3 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 3 for 1 3 for 2 5 for 2 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 2 for 1 Announcement 4/5/65 2/1/66 1/28/66 2/18/66 4/20/66 1/31/67 3/1/67 5/24/67 9/18/67 2/28/68 2/27/68 12/8/67 6/20/68 5/7/68 8/5/68 7/24/68 1/23/69 1/16/69 2/24/69 2/12/69 NA 4/25/69 2/11/69 5/5/70 12/21/70 Name 1. 6. Gypsum Mead Corp.57 25. 2. 4. 14.71 9. 11. 20. 16. 24. 12.71 14.57 14.00 17.14 13. 17.71 6. 21. 19.57 5. 7. 22.86 9. Nickel Hilton Hotels Gulf Oil Neptune Meter Burroughs Ntl. 13.00 NA 14. 5.71 15. 9.85 12. Phillips Petroleum Owens Corning General Electric Split 6/16/65 4/27/66 6/1/66 6/9/66 7/18/66 5/22/67 6/1/67 7/3/67 11/24/67 4/8/68 4/15/68 6/4/68 8/12/68 8/19/68 10/8/68 10/28/68 3/11/69 4/29/69 5/6/69 5/7/69 5/16/69 6/3/69 6/16/69 7/28/70 6/8/71 A Days 72 85 124 111 89 111 92 40 67 40 18 178 53 104 64 96 47 103 71 84 NA 98 125 84 169 A Weeks 10.14 .71 10.71 15. 18.29 12.14 17. 23. Superior Oil Koppers Co.Stock Splits 139 6 70 t IO 0o )30 at So -10 -60-50 -4O -3O . 10. Standard Brands Hammermill Paper Allied Stores Continental Airlines Revere Copper & Brass Eastern Airlines Borg Warner Adams Express Eagle Picher Texasgulf Goodrich Intl. 3.85 13.43 7.86 12.14 5.20 -0o Figure A-1.

William H.5.00-23.5.000-500. 1966) is four cents on each $100 of the money involved.3% 1.99 25. "Price Changes of Stock Dividend Shares at Ex-Dividend Dates." Journal of Financial Economics (December 1974).3% 9% . 5.00 Plus (for each round lot) 1st to 10th round lot 11th round lot and above $6 per round lot $4 per round lot 4.50 3. Beaver.00-7.99 8.. a commission surcharge (for 100 shares or less) is added to the schedule applicable to the period January 1. 2. 8.00-9.40 6.00 66-73 $1. Copeland.00 4. "Effective Stock Splits.00 12. "Evaluation of Stock Dividends.00 $82.2. The minimum tax is 4. 1972 and May 1. 1963 to April 6. C. the multiple round-lot computation is as follows: Money Involved in Order $ 100.00-24.50 2.99 10. G3.00 $22. 1972." Journal of Finance (September 1959).40 12.00 4. Barker. 5. "A Model of Asset Trading Under the Assumption of Sequential Informational Arrival.500 2.00 2.30. 1970 and March 24.1% Bi $ 3.25 1.99 4. per share on stocks worth more than $200/share. C.3% 1.00 3.00 4. 6.00 39. .00 12.00 4. New York State tax changed on July 1.00 7. 7.00-49. C.000 Minimum Commission 1. "A Reexamination of Stock Splits Using Moving Betas.9%plus .00 12.00 63-66 $1. Austin Barker. George Benston and Robert Hagerman.00 2.00 22. Austin Barker.00 $142. 3. and the maximum tax is 8. "Determinants of Bid-Ask Spreads in the Over-theCounter Market." Harvard Business Review (July/August 1958).9% B2 $ 6.00 7.75 5.140 The Journal of Finance Table A-2 Taxes and Commission Rates on a Round Lot (100 Shares) Commission = A (Price) + B New York State Tax Price/Share 3. Between April 6. REFERENCES 1.000 20.99 5.00 1.4%plus $12. 1970." Journal of Finance (September 1977).00 7.000 30.99 24.00 22.00 19.99 50. whichever is less. Sasson Bar-Yosef and Lawrence Brown.20." Journal of Finance (September 1976). "The Information Content of Annual Earnings Announcements.000. 4.500.00 3/24/72-5/1/75 B2 2% 2% 2% 1.25 2. Federal tax paid by the seller (1963 to January 1. Thomas E. 1975. Austin.6%plus ." Econometrica.99 20. 3.00 19.00 5.00 7.00-19.00 1/1/63-4/6/70 Al 2% 1% 1% 1% 1% 1% 5% 5% . C.00 .00-4." Empirical Research in Accounting: Selected Studies (1968). Chow. The SEC fee paid by the seller (1963 to 1973) is one cent for each $500 or fraction thereof of the money involved. 2.3%plus ." Harvard Business Review (January/February 1956). 1966. Between March 24. 28 (1960). "Tests for Equality between Sets of Coefficients in Two Linear Regressions.00 Notes: 1.00 .40 6.00 7.3% 1. The surcharge is 50%of the commission or $15.

Introduction to Mathematical Statistics. 24. Miller and Myron Scholes. Jaffee. 1972). Seha M." Explorations in Economic Research (Summer 1975). A. Hicks. Kenneth D. "The Analysis of World Events and Stock Prices. ed. Thomas Epps and Mary Epps. Volume XXII. "Risk and Return: The Case of Merging Firms. 20. "The Adjustment of Stock Prices to New Information. Joseph Coriaci and David Rubin. Alfred E. "A Further Development of Tests of Normality. Joseph F. Neil." Econometrica (March 1976). Victor Niederhoffer." Bell Journal of Economics and Management Science (Spring 1974). West and Seha M. 1 (1954). Smith. 1971). 28. G. 23. Potluri Rao and Robert LeRoy Miller." Journal of Finance (June 1972). Dhrymes. Pearson. 22." Journal of Finance (December 1966). 38." Journal of Political Economy (August 1976). No. Silber. 29. J. W. 10. Largay. Alan Kraus and Hans Stoll. Tinic." Journal of Financial Economics (January 1977). 37. Robert Merton. 14. Eugene F. Copeland. Kahn." Quarterly Journal of Economics (February 1972). Series B. 17. "The Economics of Liquidity Services." American Economic Revieuw(September 1975). F. Harold Demsetz. Durbin." International Economic Review (February 1969)." Journal of Financial Economics (December 1974). 27. Volume I. Gershon Mandelker. 11. "Competition and the Pricing of Dealer Service in the Overthe-Counter Stock Market. Garbade and William L. 18. Value and Capital. 1971). Michael Jensen. "A Probability Model of Asset Trading. Hausman. "Price Dispersion in the Government Securities Market. Egon S. Inc."Nonrandom Price Changes in Association with Trading in Large Blocks. 16. 25. Keith B." Journal of Business (January 1971). 36. Larry Dann. R." Biometrica. Epps. Stuart." Econometrica (May 1970). "Security Price Changes and Transaction Volumes: Theory and Evidence. 34." Journal of Finance (May 1976).Stock Splits 141 9. "Stock Splits and Price Changes. 2nd edition (Oxford: The Clarendon Press. Inc. Michael Jensen and Richard Roll. Calif. 32. Richard R. (New York: Praeger Publishers." Journal of Financial and Quantitative Analysis (November 1977). 35. R. "The Stochastic Dependence of Security Price Changes and Transaction Volumes: Implications for the Mixture-of-Distributions Hypothesis. F. 19. Keith V. 1962). 1971). 1939). Fama. Foster and A. Panelists." Journal of Financial Economics (January 1977). "Stock Splits. H. G. "The Effect of Regulation Changes on Insider Trading. "Trading Rules. Distributed Lags: Problems of Estimation and Formulation (San Francisco: Holden Day." Studies in the Theory of Capital Markets. Merton H. R. J. Paul Grier and Peter Albin. "Rates of Return in Relation to Risk: A Re-examination of Some Recent Findings. "The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns. William Schwert." Journal of the Royal Statistical Society. 3rd edition (New York: Wiley. West and J. "Stock Exchange Seats as Capital Assets. "Distribution-Free Tests in Time-Series Based on the Breaking of Records. "Development of a National System for Clearing and Settling Securities. Thomas W. Applied Econometrics (Belmont. Large Blocks and the Speed of Adjustment." Journal of Financial and Quantitative Economics (June 1972). The Economics of Regulation: Institutional Issues (New York: John Wiley and Sons. William Feller. 13. Inc.. Johnson. Portfolio Management (New York: Holt. 26.. 1968). Hoel. Phoebus J. Thomas E. An Introduction to Probability Theory and Its Applications. Volume XVL. 33. 30.. "Price Impacts of Block Trading on the New York Stock Exchange. 12. and Trading Profits: A Synthesis." Quarterly Journal of Economics (January 1977).. Paul G. Eli Weinberg. 21.. "The Cost of Transacting. 1971). 3rd edition (New York: John Wiley and Sons. Lawrence Fisher. J. 31. Rinehart and Winston. "Testing for Serial Correlation in Least-Squares Regression When Some of the Regressions Are Lagged Dependent Variables." Journal of Business (July 1973). Tinic. .: Wadsworth Publishing Co. David Mayers and Robert Raab." Journal of Business (April 1971). Price Changes. 15. Inc.

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