there is the belief that the prices of stocks that split increase in value because the shares are priced lower,which will increase demand for them. in contrast, advocates of the efficient markets would not expect a change in value, because all the firm has done is issue additional stock and nothing fundamentally affecting value has occurred.
the first study is known as ffjr(fama, fisher, jenson, and roll) contribution of the study include, 1. the long run effect of splits on returns to stockholders,2. evidence of the semistrong efficient mkt hypothesis because they were concerned with how rapidly prices would adjust to the economic event,3.adjusts for mkt effects based on capital mkt theory.
the hypothesis is splits alone do not cause higher rates of return because they add nothing to the value of the firm.ie, there should be no significant price change following a split. also, one would hypothesize that in an efficient mkt, investors would adjust for the split prior to the announcement, because all relevant information has already been discounted. it is contended that the split is caused by increase that leads a company to the split is caused by increased earnings or other important successes, and this information is known and adjusted for prior to the split
another reason for expecting an increase is that the company typically raises their dividends when they split the stock, it is contended mgmt expects a new higher level in the future. therefore the price increase accompanying the dividend increase is not caused by the dividend itself but by the information transmitted by the increase.
to determine effect, a 20 month period was used and abnormal returns were computed for the period, hypothesized that if there was any abnormal information to be derived from the split , it would show up in the residuals(deviations from a regression line) the residuals would be considered abnormal returns/changes. if there were positive residuals surrounding the split this was indicative of good information and vice a versa.purpose being to determine when the effects took place,before or after the split. the study thus divided the stocks into two groups, ones that split and increased their dividend and ones that split and did not increase dividends.
both groups experienced positive abnormal patterns before the split. stocks that did not increase their dividend experienced abnormal price declines after the split,within 12 months all residual gains were lost if there was no dividend increase.
stocks that increased dividends experienced no change in their abnormal return pattern after the split,ie,the abnormal pattern flattened. this indicates that the full impact of the price change took place prior to the split, but appeared to maintain their original abnormal increase
result, the split alone does not result in higher rates of return for stockholders and support the semistrong mkt hypothesis because they indicate the price adjustment occurred prior to the split.
they also concluded that an investor could not gain after the announcement, it was contended that the rising price pattern was due to the aggregation of returns prior to announcement.
the study was confirmed in a second study which specifically examined the profit opportunity. in contrast, charest, found large positive residuals surrounding the announcement. a fourth study, focusing on daily price and volume data supported the semistrong efficient mkt hypothesis for the period surrounding the announcement.
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