Review of Quantitative Finance and Accounting, 14 (2000): 67±84
# 2000 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Rationality of Stock Splits: The Target-Price Habit
RAYMOND W. SO
School of Management, Chinese University of Hong Kong, Shatin, New Territories, Hong Kong, China
School of Management, Binghamton University (SUNY), Binghamton, NY 13902-6015, USA
Abstract. The question of why ®rms exercise stock splits has inspired research for some time. Signalling and
optimal trading range hypotheses are possible explanations for stock splits. This paper considers the sociological
aspects of maintaining a stable target-price habit. It argues that one of the principal reasons for stock splits is to
conform to the market norm, which is established by mutual reinforcement among ®nancial analysts, managers,
and investors. Models based on economic reasons alone do not fully explain the rationality of stock splits.
Key words: stock splits, economic rationality
JEL Classi®cation: G32
A number of recent papers have proposed models that ascribe economic rationality to
stock splits. In this paper, however, we study the sociological aspects of target-price policy
in the framework of corporate culture. The reason for this approach is that many ®rms
which split on a recurring basis maintain fairly stable target prices. The target price here is
de®ned as the pre-split price divided by the split factor. The habit of stock splits may
re¯ect societal behavior; for example, a ®rm will split when its stock price hits $60 or
when its price greatly deviates from a market average.
Although stock splits per se are merely accounting changes with no change in ®rm
value, many studies (e.g., Grinblatt, Masulis, and Titman, 1984; Lamoureux and Poon,
1987) have demonstrated positive stock price reactions in response to such
announcements. Among these studies is the application of signalling models (e.g.,
McNichols and Dravid, 1990). However, the positive announcement effect is not restricted
to ®rms that have experienced or will experience improvements in dividends or earnings.
As a result, it is not clear whether management intends to use stock splits as signals.
The study of these price reactions is further complicated by the fact that stock split
announcements are usually made in connection with other corporate information releases.
It is dif®cult to measure the effect of a ``pure'' split. Moreover, negative responses to
Address correspondence to: Raymond W. So, Department of International Business, Chinese University of Hong
Kong, Shatin, New Territories, Hong Kong, China. E-mail: email@example.com.