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

2. 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. 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. 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. 5 Motivation Focus on changes in the components of equity risk Identify the sources of changes in post- split stock return volatility

6. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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