Risk Changes Following Ex-Dates of Stock Splits

1. Risk Changes FollowingEx-Dates of Stock Splits Shen-Syan Chen National Taiwan University Robin K. Chou National Central University Wan-Chen Lee Ching Yun University

2. Introduction • Ex-dates for a stock split • Changes in the number of shares outstanding and in the level of stock price • Should not affect the distribution of stock returns • But, shifts in the riskiness of the stocks have been found • Stock return volatilities tend to increase significantly following split ex-dates

3. Introduction • Increase in volatility after split ex-dates • Ohlson and Penman (1985), Lamoureux and Poon (1987), Dubofsky (1991), … • There have not been explanations for the increase in volatility • Microstructure biases do not explain the increase • Desai et al. (1998) and Koski (1998)

4. Motivation • Analyze the changes in the riskiness of stocks following splits • Focus on the long-term influence of stock splits on return volatility • Up to five years subsequent to ex-dates • Previous studies examine shifts in stock return volatility for a short period, usually less than one year following the splits

5. Motivation • Focus on changes in the components of equity risk • Identify the sources of changes in post-split stock return volatility

6. Hypothesis • Equity risk contains systematic and unsystematic risks • Hypothesis 1. There is an increase in equity betas after stock splits • Hypothesis 2. There is an increase in the residual variance after stock splits

7. Hypothesis • By Hamada (1972) • Hypothesis 3. Any increase in post-split equity betas is due to an increase in asset betas • Hypothesis 4. Any increase in post-split equity beta is due to an increase in financial leverage

8. Hypothesis • Hypothesis 4. Increase in post-split betas result from changes in splitting firms’ asset structure • High capital expenditures which are offset by the sales of assets • Hypothesis 5. Increase in post-split betas result from market reassessment of the risk of the splitting firm’s existing assets • Lack of unusual investment activity for the splitting firms

9. Data • Sample of stock splits • All splits from NYSE, AMEX and Nasdaq during 1981-1998 • Excludes regulated utilities and financial institutions • The splits must have a split factor of at least 25% • No cash dividends or other stock distribution of 25% or more within 5 years after the split

10. Data • Matched samples (Lewis et. al (2002)) • Matched by industry (two-digit SIC), asset size (25% to 200% of the splitter), and normalized operating income (OIBD/Asset) • The comparison firm does not have any stock distribution of 25% or more within 5 years before and after the sample firm’s ex-date

11. Methodology • Focus on the long-term influence of the splits on return volatility • Calculate risk measures for both sample firms and matched firms, then compare • To control for the industry effect • T-statistics and Wilcoxon signed rank statistics are calculated for testing differences in mean and median, respectively

12. Empirical Results • Changes in total equity risk (Table 2) • Splitting firms in general have lower total equity risk than the control firms • Relative to non-splitting firms, splitting firms experience a significant increase in total equity risk in the first year after splits • The increases in total equity variances in the first year appear to be transitory

13. Empirical Results • Changes in systematic risk (Table 3) • Splitting firms have higher systematic risk than the control firms, in contrast to the total equity risk results • Significant increase in systematic risk for splitting firms, relative to non-splitting firms in year +1 • Consistent with Hypothesis 1 • But, this increase also seems to be temporary (see results from year +2 to +5)

14. Empirical Results • Changes in unsystematic risk (Table 4) • Splitting firms have lower unsystematic risk than the control firms • Significant increase in unsystematic risk for splitting firms, relative to non-splitting firms in year +1 • Consistent with hypothesis 2 • But, this increase seems to be temporary (see results from year +2 to +5)

15. Empirical Results • Changes in asset risk (a component of the systematic risk) (Table 5) • Splitting firms generally have higher asset risk than control firms • Asset risk for splitting firms only increase in year +1, so it appears to be transitory • The post-split increases in equity betas are due to increases in splitting firms’ asset betas • Consistent with Hypothesis 3

16. Empirical Results • Changes in financial risk (a component of the systematic risk) (Table 6) • Splitting firms have lower financial risk than control firms • The debt ratios of splitting firms do not increase after splits, relative to non-splitting firms • The post-split increase in equity betas are not due to increases in the splitting firms’ financial leverage • Inconsistent with Hypothesis 4

17. Empirical Results • Why does asset risk change? (Table 7 & 8) • Changes in asset structure or market reassessment of the risk of existing assets? • A temporary increase in capital outlays for the splitting firms in year +1 is identified in Table 7 • From Table 8, there is no significant change in net capital outlays for the splitting firms • These imply that splitting firms are engaged in a replacement of assets in year +1 • Consistent with Hypothesis 5, rather than Hypothesis 6

18. Empirical Results • Why stock return volatility increase temporarily after stock splits? • Asset restructuring in year +1 increases asset risk • Asset risk in turn increases equity risk • Equity risk increases result in stock return volatility increases • This study shed new light on the source of changes in post-split volatility

19. Robustness Checks • Stock splits lead to a significant change in the trading activity of splitters • This may affect the estimates of systematic risk (Scholes and Williams (1977)) • Apply the AC method by Dimson (1979) to re-estimate equity betas and asset betas • Empirical results in the paper remain unchanged (Table 9 and Table 10)

20. Robustness Checks • Daily data may be prone to bid-ask bounces and price discreteness errors • Use of weekly data can correct for this problem (Koski (1998)) • We use weekly data to re-estimate equity risk, systematic risk, unsystematic risk, and asset risk • Empirical results in the paper remain unchanged (Table 11)

21. Conclusions • This study focus on the long-term influence of stock splits on return volatility • Splitting firms experience a significant increase in total equity variance in year +1 • But the increase is temporary • A result that has not been found before

22. Conclusions • Identify sources of the changes in stock volatility subsequent to stock splits • The increase in stock volatility after stock splits is ultimately driven by the asset restructuring by the splitting firms • Asset restructuring induces increases in asset risk (business risk), systematic risk, and eventually total equity risk • Residual return variance also contribute • Financial risk does not change