Is Share Price Related to Marketability? Evidence from Mutual Fund Share Splits

Abstract

We examine the "marketability hypothesis," which states that stock splits enhance the attractiveness of shares to investors by restoring prices to a preferred trading range. We examine splits of mutual fund shares because they provide a clean testing ground for the marketability hypothesis, since the conventional rationales for common stock splits do not apply. We find that splitting funds experience significant increases (relative to non-splitting matched funds) in net assets and shareholders. Stock splits do appear to enhance marketability. Although practitioners suggest that marketability is the primary reason for executing a split (e.g., Baker and Gallagher, 1980;Baker and Powell, 1993), few papers have rigorously explored this possibility. However, academic research on common stock splits has found some support for the marketability hypothesis. For example, Lamoureux and Poon (1987) and Maloney and Mulherin (1992) report that the number of shareholders increases following common stock splits. Schultz (1999) shows that the number of small orders increases following a stock split, and that the bulk of these orders are buys.2 Angel, Brooks, and Mathew (1997) show that trading activity by small investors increases following a stock split. Fernando, Krishnamurthy, and Spindt (1999) show that firms going public appear to use the offering price to influence investor interest in the issue. The evidence on common stock splits is also consistent with competing explanations, such as the trading-range hypothesis (Lakonishok and Lev, 1987;McNichols and Dravid, 1990), the signaling hypothesis (Asquith, Healy, and Palepu, 1989;Desai and Jain , 1997) or a fusion of the two (Ikenberry, Rankine, and Stice, 1996).According to the trading-range hypothesis, roundlot constraints and transaction cost considerations result in a preferred price level, which is restored by the split. According to the signaling hypothesis, managers implement stock splits to communicate favorable private information about the firm's prospects.However, these competing explanations do not fit very well the case of mutual fund splits.3 Existing transaction cost and constraint-driven explanations of a trading range do not apply, since mutual funds do not trade in ticks and any transaction costs or trade size restrictions are not related to share prices. Also, 1 We thank Chris James for suggesting this leader. 2 Schultz (1999) finds no support for tick-size explanations f o r s t o c k s p l i t s . H e c o n c l u d e s t h a t s p l i t s b r o a d e n t h e shareholder base by encouraging purchases of the firm's stock especially among small investors. However, Porter a n d We a v e r ( 1 9 9 7 ) c o n c l u d e t h a t a r e d u c t i o n i n t h e minimum tick size by the Toronto Stock Exchange reduced trade execution costs and may benefit small traders. 3 Excepting the recent paper by Rozeff (1998), mutual fund splits have not been widely studied in the academic literature. They were noticed early by Barker (1956).

Are share price levels informative? Evidence from the ownership, pricing, turnover and performance of IPO firms

“…In particular, studies by Muscarella and Vetsuypens (1996), Fernando et al (1999), Schultz (2000), and Dhar et al (2003) provide empirical support for the notion that lower share prices make stocks more attractive to individual investors. These findings are consistent with surveys of managers by Baker and Gallagher (1980) and Baker and Powell (1993), which report that maintaining a preferred price level is the primary motivation for stock splits.…”

“…Anshuman and Kalay (2002) argue that firms select an optimal stock price to minimize the total expected costs of liquidity trading, including adverse selection costs, discreteness-related costs and the opportunity costs of monitoring. Fernando et al (1999) show that splits increase marketability of shares to retail investors, and Schultz (2000) concludes that splits broaden the shareholder base by encouraging the purchase of a firm's stock by small investors. Dhar et al (2003) examine the trading of individual investors around stock splits and find that splits are associated with a shift towards less sophisticated individual investors.…”

The information content of stock splits

“…They argue that stock splits may be designed only to improve the marketability of split stocks either because the post-split price meets certain investor specific preferences (see Lakonishok and Lev, 1987;Dyl and Elliott, 2006 for the trading range hypothesis), or because splits provide other market participants such as market makers with more incentives to promote the stocks (see Angel, 1997;and Schultz, 2000 for the optimal tick size hypothesis; and Kadapakkam et al, 2005 for broker promotion hypothesis). Studying splits that are clearly devoid of any information, researchers find support for the non-information or marketability explanation (see Fernando et al, 1999;and Rozeff, 1998 for mutual fund splits; and Muscarella and Vetsuypens, 1996 for American Depository Receipt (ADR) solo-splits). Easley et al (2001) do not find any reduction in information asymmetry following stock splits, suggesting the absence of information around split announcement.…”

Stock Splits as a Manipulation Tool: Evidence from Mergers and Acquisitions

“…By examining mutual fund share splits,Fernando, Krishnamurthy, and Spindt (1999) also find that share price levels are related to the marketability of mutual funds.…”