Market Reaction to Stock Split

Topics: Stock market, Stock, Stock exchange Pages: 27 (7288 words) Published: May 5, 2013

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Bonus issues are simply distribution of additional stocks to the existing shareholders. It is a “free” issue of shares, without a subscription price, made to existing shareholders in proportion to their current investment. A firm can distribute bonus shares by using retained earnings or accumulated capital reserves. The relationship between Bonus issues and share prices has been the subject of much empirical discussion within the finance literature. Empirical research (particularly in US) has shown that the market generally reacts positively to the announcement of a bonus issue. The hypothesis that has received strongest support in explaining the positive market reaction to bonus issue announcements is the signalling hypothesis. A company can distribute bonus stocks by using retained earnings or accumulated capital reserves. If a company distributes a bonus issue by using retained earnings, it makes a book entry to allocate retained earnings into paid- capital in the stockholders‘ equity section of the company balance sheet. Alternatively a company if decides to distribute a bonus issue by using accumulated capital reserves, it adjusts the accumulated capital reserves into paid-up capital. In both the cases the company does not receive any cash. Thus they result in each stockholder holding a greater number of stocks, but with more stocks on issue their relative claim on the assets of the company is smaller.

There is no effect on stockholder‘ s proportional ownership of stocks, capital structure and financial position of company. Since bonus issues do not enhance earning power, change the firm‘s capital structure, or result in expense reductions, the total market value of the firm in absence of information asymmetries should remain the same Only modification triggered by the bonus issue is that the number of outstanding stocks is adjusted by the bonus issue ratio, therefore, the price of the stocks declines according to the same bonus issue ratio The total market value of the stocks or the value of the stocks that are held by each investor should remain unchanged. STOCK SPLITS

Stock split is reduction in denomination (face value) of the shares. Shares in the past were issued in standard denominations such Rs. 10, Rs. 100, etc. Over many years with performance and growth, the share price of some of the companies has appreciated. E.g. Grasim has a face value of Rs. 10 however; the price of one share in Grasim is Rs. 2600. For small investor this may appear a little beyond his or her means to own the shares in Grasim. This problem of owning shares was more pronounced when securities were traded in lots of 50 sharesand100shares.

Therefore to make appear the security price within the reach of small investors, the companies decide to split the stock denomination (face value). When stock denomination are split say from Rs. 10 to Re.1, the market price is adjusted in same proportion.

In case of the stock splits the par value of the shares is decreased. The amount of shares to be issued is increased in proportion to the reduction in the value of the shares. Essentially, if you have 10 shares of face value of Rs 10 each, you will have 50 shares of Rs 2 each if a company puts through a 10-to-2 stock split. When a company splits its stock, you have more shares but of a lower denomination. So the value of your holdings should remain unchanged. The implication is that by splitting the shares even small investors can afford to buy the shares of large company

Empirical studies in...

Bibliography: 1. Dr. A.K. Mishra, Associate Professor, Indian Institute of Management, (2005) “An empirical analysis of market reaction around the bonus issues in India”
3. Jijo Lukose P. J.( December 2002); “Does bonus issue signal superior profitability? A study of the BSE Listed Firms”
5. Rao, K Chandra Sekhara and Geetha, T (1996), Indian Capital Market: Informational Signaling and Efficiency, New Delhi:A.P.H. Publishing Corporation.
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