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J Econ Finan (2011) 35:7178 DOI 10.

1007/s12197-009-9115-1

News and noise: do investors react to stock split announcements differently during periods of high and low market volatility?
Steve Johnson & Robert Stretcher

Published online: 3 December 2009 # Springer Science+Business Media, LLC 2009

Abstract In this paper, we find evidence that stock split announcements have a greater wealth effect when market volatility, as measured by the VIX index, is low. This effect is driven primarily by small firms. These results support the hypothesis that when market volatility is high, signals sent by small firms are more likely to be obscured by noise than when market volatility is low. Keywords Stock Splits . Noise . Information . Abnormal Returns . Volatility . Event Study . VIX JEL Classification G14 In this paper, we study the possible information content in stock split announcements. In particular, we are interested in gaining further insight into the stock price reaction around the announcement of a stock split. While a stock split is technically just a change in denomination of the value of a firm, it has been documented that a positive cumulative abnormal return occurs, in general, around the announcement dates for these splits (e.g., Fama et al 1969). One common interpretation of this phenomenon is that the split has information content; that by splitting the firms stock, managers are attempting to signal to outsiders that management believes that the firms stock price will increase (e.g., Ikenberry and Ramnath 2002). This paper focuses on a more refined expectation of the information content hypothesis. If the information content of the announcement is value-relevant, then it follows that a signal may be more obscured during times when market volatility is high and market noise abounds, and that a signal may be easier to send when the market is relatively calm, such that hand-waving is more effective in gaining attention. Additionally, we explore whether any conclusions can be drawn concerning large versus small firms.
S. Johnson (*) : R. Stretcher Sam Houston State University, Box 2056, Huntsville, TX 77341, USA e-mail: sjj008@shsu.edu R. Stretcher e-mail: rstretcher@shsu.edu

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1 Literature review The finance literature yields considerable evidence that positive cumulative abnormal returns (CARs hereafter) follow stock split announcements. Some articles credit informational signaling for the positive CAR result, while others argue a liquidity effect; that by going from a higher price to a lower price, a firms shares become more liquid because of a smaller denomination unit (e.g., Brennan and Hughes 1991; Conroy and Harris 1999; Ikenberry et al 1996). Three stock-split event studies are particularly relevant to our paper. Fama, et.al. (1969) found that positive abnormal returns occur in the month of the announcement, and that abnormal returns were essentially zero in the months following the announcement month. NYSE and Amex firms yielded additional knowledge in a study by Ikenberry, et. al. (1996). The study concluded that a significant positive abnormal return occurred in a five-day window surrounding 2-for-1stock split announcements during the period 19751990. It also suggested relationships of abnormal returns with the post-split price, market capitalization, and the book-to- market ratio. Recently, Chern et. al. (2008) showed that abnormal returns surrounding splits were significantly lower for optioned versus non optioned stocks, supporting the idea that the information environment has a profound effect on the price reactions around split announcements. Perhaps the most compelling encouragement for this study, however, was the decline in announcement period abnormal returns over certain time segments identified by Ikenberry, et. al. (1996): the periods from 19751980, 19811985, and 19861990. If, indeed, the signaling argument is valid, it follows that certain market conditions may magnify or obscure the hand-waving that a firm tries to affect in order to gain attention. Previous research, including Lang and Lundholm (1993), conjectures that high volatility may be a proxy for the information environment. Docking and Koch (2005) in their study of dividend change announcements, find that announcements to lower dividends are followed by a greater decrease in stock price during periods of high volatility and high market returns. Since there is evidence that different information environments affect excess stock returns around stock split announcements (Chern et al 2008), stock price volatility can be used as a measure of the information environment (Lang and Lundholm 1993), and stock market volatility does have an effect on excess stock returns around another corporate announcement, dividend changes (Docking and Koch 2005), our intent is to provide further insight by separately examining the price impact of stock splits during different volatility regimes by using the VIX volatility index.

2 Methodology and results We begin with the reasoning that during high volatility periods, information signaling is more obscured, and thus the positive abnormal returns would not be as significant as in low volatility periods. Previous researchers, such as Lang and Lundholm (1993), conjecture that stock return volatility proxies for information asymmetry, which managers try to reduce through improved disclosure. To test this reasoning, we parse the VIX volatility index into terciles in order to clearly differentiate between high volatility and low volatility periods. For inclusion in the

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study, stock splits had to be available in the CRSP daily stock database, within the term from 1990 to 2007. The lower limit was due to the availability of the VIX, which began in 1990. An event study window of 2 to +2 (a five-day window surrounding the announcement date) was used. Cumulative abnormal returns (CARs) were recorded during the window surrounding each stock split announcement. In order to distinguish a difference in the CAR between high and low volatility periods, we first ran the following regression test: CARi b0 * Low volatility b1 * Medium volatility b2 * High volatility Where Low_volatility Medium_volatility and High_volatility 1 if the event occurs during VIX tercile 0, and 0 otherwise 1 if the event occurs during VIX tercile 1, and 0 otherwise 1 if the event occurs during VIX tercile 2 and 0 otherwise. H 0 : b 0 b2 2 1

Our null hypothesis was

An F-test was run in order to see if there was support for a difference between the mean CARs recorded for high volatility periods (upper VIX tercile) versus CARs for low volatility (lower VIX tercile) periods (null hypothesis: no difference in the mean CAR's).The results are shown in Panel A of Table 1. The difference between the two populations has the predicted sign and is marginally statistically significant (p-value of 6.22%). This lends evidence to the notion that the excess returns over the announcement period of stock splits have greater positive excess returns during lessvolatile market periods. The second question addressed by the study was based on the notion that small firms, being less observed in general, may have a better chance of achieving a response by splitting their stock than a large firm that is constantly monitored. Perhaps larger firms' actions are better observed and more anticipated, and thus, a split would not be much of a surprise or have as much of a signaling response. The sample was divided into terciles based on market capitalization. In order to distinguish a difference in the CAR between large, medium, and small firms, we ran the following regression test: CARi b0 * Small size b1 *Medium size b2 *Large size Where Small_size Medium_size and Large_size 1 if the event occurs during VIX tercile 0 and 0 otherwise 1 if the event occurs during VIX tercile 1 and 0 otherwise 1 if the event occurs during VIX tercile 2 and 0 otherwise. H 0 : b 0 b2 4 3

Our null hypothesis was

Based on the data, it was not possible to reject the null hypothesis. There was no statistically-significant difference between small and large firms.

74 Table 1 Regression results for volatility and size Panel A: Results distinguished by VIX (market volatility) tercile Low volatility 0.0126 (0.0074)* F-Stat small size 0.0107 (0.0085) F-stat Medium volatility 0.0016 (0.0083) 3.49 medium size 0.0028 (0.0082) 0.86 p-value p-value

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High volatility 0.0104 (0.0099) 0.0622 large size 0.0003 (0.0084 0.3543

Test of the difference between high volatility and low volatility terciles: Panel B: Results distinguished by size (market capitalization) tercile

Test of difference between large size and small size terciles:

This table reports the results of the regression: CARn b0 * C0 ::: b2 *C2; where CARn is the cumulative abnormal return for event n, the b0,...,b2 are regression coefficients and where the dummy variables C0,,C2 are defined differently for panels A and B: Panel A: Ci =1 if the firm/date pair are in VIX tercile I, and=0 otherwise. Terciles 0, 1, and 2 represent low, medium, and high volatility, respectively Panel B: Ci =1 if the firm/date pair are in market capital tercile I, and=0 otherwise. Terciles 0, 1, and 2 represent small, medium, and large firms, respectively. Values reported are coefficients from the regression. Values in parentheses are standard errors *** represents statistical significance at the 1% level ** represents statistical significance at the 5% level * represents statistical significance at the 10% level

To test for the possibility that size and volatility do not have independent effects on stock performance, a regression model was formed using the CAR as the dependent variable and a set of nine dummy variables representing the crossproducts of the three volatility tercile dummies and the three total stock market capitalization terciles as independent variables.
CARi b00 *Low volatility&Small size b01 *Low volatility&Medium size b02 *Low volatility&Large size b10 *Medium volatility&Small size b11 *Medium volatility&Medium size b12 *Medium volatility&Large size b20 *High volatility&Small size b21 *High volatility&Medium size b22 *High volatility&Large size

where Low volatility&Small size Low volatility*Small size:

The other dummy variables are defined in a similar manner. The coefficients are indexed as: bij =1 if the event occurs during VIX tercile i and size tercile j, and 0 otherwise, where i=0 (low VIX tercile), 1 (middle VIX tercile), or 2 (high VIX tercile), and where j=0 (low size tercile), 1 (middle size tercile), and 2 (high size tercile).

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Regression results appear in Table 2. The lowest volatility and largest size dummy shows a marginally significant result (significant at the 10% level); curiously negative in sign. The lowest volatility and smallest size result is positive and significant at the 1% level. To see if differences exist between the regression coefficients, we test the difference between the high volatility environment and the low volatility environment for small-cap firms. The results are reported in Table 3. Our null hypothesis was H0 : b00 b20 6

The difference is significant at the 1% level. This provides evidence for the argument that for small cap firms, the stock price reaction to stock split announcements is significantly greater during periods of low market volatility. For comparison, we also looked at large-cap firms. Our null hypothesis in this case was H0 : b02 b22 7

We could not reject the null hypothesis of no difference between different volatility environments for large firms. Table 4, panel A reports the number of firms making split announcements in each size/volatility category. In panel B, a chi-squared test is presented with the null hypothesis that noise (volatility) levels have no effect on the occurrence of announcements. The test indicates that a difference does indeed exist. Panel C tests whether the proportion of small firms making split announcements differs between low and medium volatility markets and beetween low and high volatility markets.
Table 2 Regression results for volatility and size, combined Low volatility Small size Medium size Large size 0.0492 (0.0131)*** 0.0068 (0.0142) 0.0308 (0.0174)* Medium volatility 0.0118 (0.0130) 0.0042 (0.0133) 0.0009 (0.0167) High volatility 0.0027 (0.0120) 0.0032 (0.0157) 0.0029 (0.0167)

This table reports the results of the regression: CARn b00 * C00 ::: b22 * C22; where CARn is the cumulative abnormal return for event n, the b00,...,b22 are regression coefficients and where the dummy variables C00,,C22 are defined by: Cij 1 if the firm/date pair are in VIX tercile i and market capitalization tercile j Cij 0 otherwise i=0, 1, and 2 represent low, medium, and high volatility, respectively j=0, 1, and 2 represent small, medium, and large size, respectively Values reported are coefficients from the regression. Values in parentheses are standard errors *** represents statistical significance at the 1% level ** represents statistical significance at the 5% level * represents statistical significance at the 10% level

76 Table 3 Hypothesis test

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Panel A: Test of difference between high and low VIX environments for small cap firms Test b02 b00 b22 b20 Test b22 b20 Diff of coefficients 0.08 0.0056 Diff of coefficients 0.0056 F stat 6.84 0.07 F stat 0.07 p value 0.0092 0.7861 p value 0.7861

Panel B: Test of difference between high and low VIX environments for large cap firms

This table reports the results of hypothesis tests on the coefficients from the regression: CARn b00 * C00 ::: b22 * C22; where CARn is the cumulative abnormal return for event n, the b00,...,b22 are regression coefficients and where the dummy variables C00,,C22 are defined by: Cij =1 if the firm/date pair are in VIX tercile i and market capitalization tercile j Cij =0 otherwise

While the proportions cluster around one third each, a higher proportion of small firms announce stock splits during periods of low volatility. Panel D in Table 4 addresses a question of whether the evidence presented in this paper is already factored into the decision of announcement timing. If so, we might expect that large proportions of small firms would announce during low volatility than the proportions of meduim or larger firms announcing during low volatility. 40.46% of small firms, 37.27% of medium size firms, and 32.46% of large firms announce during low market volatility. While these are significantly different, it is curious that 59.54% (1.4046) of small firm announce during medium and high market volatility, since the benefit of greater CARs exist during low volatility, especially for small firms.

3 Conclusions While positive excess stock returns around stock split announcements have been documented for decades, we find new evidence that these excess stock returns vary depending on the level of market volatility. Our statistical results provide evidence to support the hypothesis that positive CARs around stock split announcements, 1) are driven by periods of low volatility and 2) are more significant for smaller firms. In our sample, the positive CARs were driven by two identifiable aspects of the market: level of market volatility and firm size. In particular, during the sample period, while the market experienced low levels of volatility (bottom tercile of the VIX index), small firms generated positive stock returns around stock split announcements. Our results also support a substantial policy recommendation. For small firms, in periods of low volatility, there may exist material gains from announcing a stock split. There exists evidence that small firms do not enjoy the same gains during periods of medium and high volatility. Conversely, especially in periods of high volatility, larger firms may have little to gain from split announcements.

J Econ Finan (2011) 35:7178 Table 4 Tests of proportions Panel A: Stock split announcement events sorted by firm size and noise level Size small Noise low medium high 831 759 464 2054 Panel B: Chi-squared tests, H0: Noise has no effect Null hypothesis: Noise has no effect on the timing of managers decisions to announce stock splits pValue 0.0000 Chi-sq statistic 65.34 medium 766 808 481 2055 large 667 730 658 2055 2264 2297 1603

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Panel C: Test of the behavior of small firms during different periods of market volatility Null hypothesis: Small firms time split announcements independently of the level of volatility Alternate hypothesis: During periods of low market volatilty, the proportion of small firms that make stock split announcements is greater than during periods of medium or high market volatility %of small firms|low noise % of small firms|medium noise %of small firms|high noise test statistic (z-score), low versus medium p value, low versus medium test statistic (z-score), low versus high p value, low versus high 0.3670 0.3304 0.2895 2.5948 0.0048 5.0366 0.0000

Panel D: Test of the likelihood of firms of different size to issue stock split announcements during periods of low market volatility Null hypothesis: Firms of all sizes make the same proportion of stock split announcements during periods of low volatility Alternative hypothesis: Small firms make a higher proportion of stock split announcements during periods of low volatility than medium or large firms. % of low noise period announcements|small firm % of low noise period announcements|medium size firm % of low noise period announcements|large firm test statistic (z-score), small versus medium p value, small versus medium test statistic (z-score), small versus large p value, small versus large 0.4046 0.3727 0.3246 2.0927 0.0183 5.3274 0.0000

This table reports the number of firms in each size/market volatility combination that make stock split announcements. The noise terciles are defined by dividing the period into low, medium, and high values of the VIX index. The size terciles are defined by dividing the firms by market capitalization into small, medium, and large categories each year. The sorts are independent of each other. Row and column sums are also reported

Table 4 suggests that a large portion of small firms announce stock splits during inopportune medium and high volatility periods. The above results should serve to convince a larger proportion of small firm management to announce stock splits during periods of low market volatility since that strategy would be more advantageous.

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Our results may help to resolve arguments concerning the extent to which split announcements have informational content, and whether attempts to signal are acted upon by market participants. It appears that 1) market participants do react differently to stock split announcements during different volatility regimes and for firms of different sizes, and 2) small firms frequently do not time stock splits in the most advantageous manner.

References
Brennan MJ, Hughes PJ (1991) Stock prices and the supply of information. Journal of Finance 46 (5):16651691 Chern Keh-Yiing, Kishore Tandon, Gwendolyn Webb (2008) The Information Content of Stock Split Announcements: Do Options matter? Journal of Banking and Finance 32:930946 Conroy RM, Harris RS (1999) Stock splits and information: The role of share price. Financial Management 28(3):2840 Docking DS, Koch PD (2005) Sensitivity of investor reaction to market direction and volatility: Dividend change announcements. Journal of Financial Research 28(1):2140 Fama E, Fisher L, Jensen M, Roll R (1969) The Adjustment of Stock Prices to New Information. International Economic Review, February Ikenberry DL, Ramnath S (2002) Under-reaction to self-selected news events: The case of stock splits. The Review of Financial Studies 15(2):489526 Ikenberry DL, Rankine G, Stice E (1996) What Do Stock Splits Really Signal? Journal of Financial and Quantitative Analysis 31(3):357375 Lang M, Lundholm R (1993) Cross-sectional determinants of analyst ratings of corporate disclosures. Journal of Accounting Research 31:24671

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