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August 31, 2012 (originally published by Booz & Company)


The Peer Pressure Posed

by Stock Splits
Companies in similar groups watch one another, then often follow the

Title: Social Norms and Corporate Peer Effects (Free)

Authors: Markku Kaustia and Ville Rantala (both of Aalto


Publisher: Social Science Research Network Working Paper

Date Published: March 2012

Peer pressure can have a powerful effect on corporate decision

making, according to this paper, which finds that stock splits
executed by companies competing in a given industry
significantly increase the likelihood that industry counterparts
will follow suit and divide their own stock — despite little
evidence of a financial benefit, at least in the short term, from
doing so.

In fact, stock splits undertaken by such peer companies had the

same persuasive effect on a firm’s decision to do likewise as
would a 40 to 50 percent increase in the price of its shares over
the previous year, the kind of run-up that often precipitates a
split. As further evidence that companies base their decisions on
a close watch of their competitors, the authors found that firms
were twice as likely to divide their stock within a year after their
peers’ having reported positive returns from a split, compared
with their reaction to reports of negative returns.

The authors see the effect of stock splits on peers as indicative of

a broader interest in what competitors are doing and as a sign of
“herding behavior.” The findings, they say, indicate that firms
scrutinize both the choices that peers make more generally and
the level of their achievement — and then emulate the winners.
“A general implication of our results,” the authors write, “is that
observations of peer firms can have a strong impact on
corporate decision making, particularly in areas in which
economic theory offers little guidance.” But even when outside
advice is available, they conclude, “actions and outcomes of peer
firms may constitute a more accessible source of information for
corporate managers, and could thus have economically
significant effects.”

In exploring how social norms affect corporate behavior, the

authors decided to investigate peer effects on stock splits
because they represent a “clean setting” for research. Splitting
stock — increasing the number of publicly traded shares while
decreasing their individual price so that the overall value
remains the same — is a decision that almost any firm can make
at any time, the authors note.

To isolate the effects of peer moves on a firm’s propensity to

split stock, and to rule out any other motives, the authors
controlled for variables related to stock price, market
capitalization, past returns, and the company’s recent history of
dividing its shares. The authors obtained stock price and split
information, as well as firm data, from the Center for Research
in Security Prices and the Compustat databases; analyst data
came from the I/B/E/S Details database.
The sample consisted of all U.S.-based firms listed on the New
York Stock Exchange (NYSE) with sufficient data available from
1983 through 2009. To measure the effect of peers, the authors
assigned the firms to groups on the basis of their analyst
following, in recognition of the fact that analysts typically
monitor companies in a specific industry. By contrast, the
conventional approach in this strand of research relies on
industry classifications, such as those used in the Fama-French
database, which are “too large to effectively identify the set of
peers subject to managers’ constant attention,” the authors

To be included in a peer group, firms had to share a threshold

number of analysts. During the survey period, an average of
1,501 firms and 2,076 analysts were in the sample each year, and
more than two-thirds of the companies belonged to an analyst-
based peer group. The average group size remained fairly
constant across the time frame, from a high of 14 in 1987 to a
low of 9.5 in 2002.

The annual number of splits varied sharply over time, however,

ranging from 354 announcements in 1983 to four in 2009. On
average, each year, 8 percent of NYSE firms split their stock, the
authors found, while the corresponding percentage for firms
with a peer group was almost 10 percent, meaning that firms
sharing analyst-based and industry connections were slightly
more likely to announce a split than those outside a group.
However, firms with analyst-based peers accounted for a
skyrocketing percentage of the total splits in the later years of
the study, increasing from 34 percent in 1984 to 92 percent in
2008, a rise perhaps fueled by the ability to track news about
competitors more closely.

One traditional explanation for splits is that they satisfy

investors’ occasional demand for low-priced stocks, and this
view suggests that “firms may believe they are making value
adding decisions by following successful splitters,” the authors

But if that’s the motivation, decision makers may be

disappointed, because the authors found scant financial benefit.
Firms that followed successful peers had stock returns that were
only 8 basis points higher than average immediately after the
split, a statistically insignificant difference.

“Managers can interpret peer firms’ splits as evidence of the

benefits of share price management,” the authors write, “and
conclude that peer firms are splitting because their
management sees that the lower nominal share price has a
positive impact on firm value.” On the other hand, they say, “it is
possible that firms overreact to observations about their peers’
actions and outcomes.”

Bottom Line:
Companies are more likely to divide their stock when peer firms
have recently done so, and especially when their counterparts
have experienced positive returns after the split. However,
following the crowd provides little financial benefit to
companies, and is primarily evidence of the powerful effects of
peer pressure on corporate decision makers.

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