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IBM To Split Shares

News

On January 28, International Business Machines Corp. (IBM) announced that it would split its stock 2-for-1, the first split since 1979.

Analysis

 Some Background on Stock Splits

What Are Stock Splits?
When a split is declared by a company, each share is split up to create additional shares. For example, in a thirty-for-one stock split, each share is split into thirty new shares.

Do Stock Splits Make Sense?
Academicians do not yet have a model to explain why firms actually split their stocks. Proponents of stock splits argue that a security has a proper trading range. A security whose price is above this range would not be affordable to many investors. This is not a very convincing argument for at least two reasons:

1. Companies do not have to be concerned with affordability on the secondary markets (exchanges) since the transactions involve exchange of ownership and not the infusion of new capital to the company; and
2. More than 80% of the trading volume on the NYSE is institutional (i.e., by mutual funds, pension funds, insurance companies, and other large investor groups), who are not affected by high stock prices.

Another argument for splits is increasing liquidity. There is evidence, however, that stock splits may actually decrease the liquidity of the company’s shares. Following a two-for-one split, the number of shares traded should more than double if splits increase liquidity. There is no support for this argument, and the reverse is sometimes observed.

Market Reaction
The market reacted favorably to the news bidding the price up by $6.75 to $152.50 on the New York Stock Exchange (NYSE).

Of course not every investor considered the news favorable. However, here is an interesting comment quoted by Greenberg, a columnist for the San Francisco Chronicle:

According to Rick Eakle of Eakle Associates in Fair Haven, N.J., the announcement was evidence that IBM will be leading the market to a tumble. His analysis was based on claiming that "IBM's stock has tumbled an average of 45 percent within one year of each of its three prior splits."

Sources: San Francisco Chronicle (January 29, 1997), WSJ (January 29, 1997)