| Abstract
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This study's objective is to provide new empirical capital market evidence on the impact of a unique natural experiment on a stock split policy which was decreed several years ago by the Saudi Arabian government. First, the capital market reaction to the government decreed stock split is assessed. In particular, the study examines whether abnormal returns are associated with the decreed stock split, whether abnormal returns are positively related to the market values of shares, and whether abnormal returns vary across market sectors. Finally, in addition to assessing policy implications, the microstructure determinants of cumulative abnormal returns associated with decreed stock split are also evaluated: ownership structure, number of trades, turnover, and trading volume. The stock splits literature has evolved dramatically in recent years. Initially, stock splits were seen as primarily "cosmetic"---stock splits were viewed as merely slicing the same "cake" into small pieces without any real benefit to stockholders. However, numerous empirical studies found evidence of abnormal positive returns associated with stock splits (e.g. Forjan and McCorry, 1998). The prevalent theoretical literature attributes a stock splits wealth effect to either management information signaling (Brennan and Copeland, 1988) or a liquidity effect (Lakonishok and Lev, 1987); (McNickols and Dravid, 1990). This study presents a unique opportunity to distinguish between these two competing hypotheses. The management signaling effect is not an issue since the stock split decision is decreed by the Saudi Arabian government. The results indicate that the market reaction to the announcement of the decreed policy is statistically significant but mixed and varies with the economic sector (industry) level. While the cement industry demonstrates positive abnormal returns, the banking, manufacturing, and service sector, in general, demonstrate negative abnormal returns. Surprisingly, the agriculture and electricity sectors demonstrate no market reaction. The study also finds that firm size is positively related to the overall market reaction, while the book to market ratio is negatively related. Finally, the study empirically shows that the stock split decreed policy goal of increasing the total number of shareholders in the market was not accomplished. However, the volume effect and number of trades varies across the sampled firms. The results of the study have important implications for both Saudi Arabian capital market policy makers and investors.
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