Department/School

Accounting

Date of this version

2009

Document Type

Article

Keywords

stock splits, trading continuity, liquidity risk, cost of equity capital

Abstract

We hypothesize that managers use stock splits to attract more uninformed trading so that market makers can provide liquidity services at lower costs, thereby increasing investors’ trading propensity and improving liquidity. We examine a large sample of stock splits and find that, consistent with our hypothesis, the incidence of no trading decreases and liquidity risk is lower following splits, implying a decline in latent trading costs and a reduced cost of equity capital. Further, split announcement returns are correlated with the improvements in both liquidity levels and liquidity risk. Our analysis suggests nontrivial economic benefits from liquidity improvements, with less liquid firms benefiting more from stock splits.

Published in

Journal of Financial Economics

Citation/Other Information

Vol. 93 (3), 474-489.