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 firms 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 firms 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