Stock Split

According to What is a stock split?,Investopedia a stock split is a company action that increases the amount of outstanding stock in the market place by a determined split ratio. This action reduces the price of the stock but increases each stakeholder total shares owned. However, the opposite can happen with a reverse stock split, this increases the stock price but also decreases the total outstanding shares. A company's board of directors mainly uses stock splits to make the shares prices similar to other companies in its sector and to make the stock more favorable to investors.

The discussion on the effects of stock splits has been the cause for various debates as different studies have found conflicting evidence on the returns of stock splits in regards to the long-term economic horizon. The cause of this debate arises out of what are the potential benefits, if any, to a company splitting their stock. After research into the topic, we came to the conclusion that companies split their stock for tangible economic benefits,and the other as more of a signaling factor.

The first being that a stock split produces an increase to the overall liquidity of the shares in the market, which allow for shares of the company to be more easily traded. If the price of the stock is high, before the stock undergoes a stock split, the results will be a very high bid/ask spread ratio, which is not usually preferred for investors. The result of splitting shares of stock can decrease the bid/ask spread range and thereby increase the liquidity of the stock as there are more shares to be traded among investors and the smaller bid/ask spread allows for more investors to fulfill orders at their specified prices. The other main reason that a company may split their stock, as speculation suggests, is for the price of the stock to remain psychologically appealing, as investors are more prone to purchase lower costing investments. This can lead to an increase in demand for the stock of the company. For investors, a stock split could be some sort of signaling factor that the company is doing well and can expect to see a revenue increase in the future.

The research paper by Desai, Hemang, and Prem C. Jain established that typical stock splits announcements are not harmful for a company nor its stakeholders, because it does not decrease the value of a stock plus the public does not frown upon this action. Stock splits allow a company to become more liquid and increase marketability to smaller investors as well. Some company's refuse to issue stock splits, such as Berkshire Hathaway, because they do not believe that lowering the stock price not be beneficial to their liquidity or marketability, but that fact that they have become a prestigious stock with abnormal long run growth.

The announcement of a stock split can be a signaling factor toward investors and can cause a short-term boost in the shares traded of a company before the split.