Do Stock Splits Share The Wealth For All?
More than 40 years of research has consistently found that stock split announcements generate positive abnormal returns. Equipped with this knowledge, do firms time CEO stock option grants around stock split announcements to sweeten the pot for their CEOs? And do CEOs trade the firm’s stocks around stock splits to boost their wealth? The answer to both questions is yes. But do these opportunistic actions by firms and CEOs hurt shareholders? Maybe … or maybe not.
William Elliott in the Boler School of Business takes a look at these questions, along with coauthors Erik Devos and Richard Warr, in their article “CEO Opportunism?: Option Grants and Stock Trades Around Stock Splits,” published in the Journal of Accounting and Economics.
The article reports that about three-quarters of all stock splits result in positive abnormal returns, pegged at just over 3%. Therefore, stock splits seem an opportune time for firms to grant stock options to CEOs. This is because stock options offer CEOs the right to buy the firm’s stock in the future (the “vesting date”) at an earlier date’s price—in this case, the announcement date of the stock split—and profit from its positive returns.
Looking at a sample of 276 stock splits from 1992 to 2012, the authors find that 80% of all CEO stock option grants are timed to occur on or before the split announcement date. Awarding the grant before the split announcement results in an average gain per grant of $451,748.
Insider trading data reveal that CEOs are busy buying and selling stocks around the time of stock split announcements. In fact, the overall amount of trading around splits is four times greater than trading in the previous year. Two-thirds of CEO purchases occur immediately before the stock split announcement and, no surprise, an equal number of CEO sales occur immediately after the announcement. Selling after versus before the stock split leaves CEOs better off to the tune of $345,613, on average.
The authors conclude that the evidence points to opportunistic behavior by both firms granting stock options and CEOs trading stocks, but they cannot say whether this behavior hurts shareholders. They find that opportunistic firms are just not that different from nonopportunistic firms.
Finally, it’s true that shareholders do not have a say in when to split stocks and issue CEO option grants—this is decided by the board of directors (sometimes with the help of the CEO). But typically, only highly successful firms engage in stock splits. Therefore, awarding stock grants around wealth-boosting stock splits could simply be another way for firms to keep, and keep happy, their high-performing CEOs.