Underreaction to Self-Selected News Events: The Case of Stock Splits

David L. Ikenberry and Sundaresh Ramnath
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David L. Ikenberry: Rice University
Sundaresh Ramnath: Georgetown University

The Review of Financial Studies, 2002, vol. 15, issue 2, 489-526

Abstract: An emerging literature looking at self-selected, corporate news events concludes that markets appear to underreact to news. Recent theoretical articles have explored why or how underreaction might occur. However, the notion of underreaction is contentious. We revisit this issue by focusing on one of the most simple of corporate transactions, the stock split. Prior studies that report abnormal return drifts subsequent to splits do not appear to be spurious, nor a consequence of misspecified benchmarks. Using recent cases, we report a drift of 9% in the year following a split announcement. We consider fundamental operating performance as a source of the underreaction and find that splitting firms have an unusually low propensity to experience a contraction in future earnings. Further, analysts' earnings forecasts are comparatively low at the time of the split announcement and revise sluggishly over time. Together these results are consistent with the notion of market underreaction to the information in corporate news events. Copyright 2002, Oxford University Press.

Date: 2002
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