This preview shows page 1. Sign up to view the full content.
Unformatted text preview: s that its stock is priced too high and that lowering
the market price will enhance trading activity. Stock splits are often made prior to
issuing additional stock to enhance that stock’s marketability and stimulate market activity. It is not unusual for a stock split to cause a slight increase in the market value of the stock, attributable to its informational content and to the fact
that total dividends paid commonly increase slightly after a split.8
Delphi Company, a forest products concern, had 200,000 shares of $2-par-value
common stock and no preferred stock outstanding. Because the stock is selling at
a high market price, the firm has declared a 2-for-1 stock split. The total beforeand after-split stockholders’ equity is shown in the following table. 8. Eugene F. Fama, Lawrence Fisher, Michael C. Jensen, and Richard Roll, “The Adjustment of Stock Prices to New
Information,” International Economic Review 10 (February 1969), pp. 1–21, found that the stock price increases
before the split announcement and that the increase in stock price is maintained if dividends per share are increased,
but is lost if dividends per share are not increased, following the split. CHAPTER 13 Dividend Policy 575 Before split
Common stock (200,000 shares at $2 par) $ 400,000 Paid-in capital in excess of par 4,000,000 Retained earnings 2,000,000 Total stockholders’ equity $6,400,000 After 2-for-1 split
Common stock (400,000 shares at $1 par) $1,400,000 Paid-in capital in excess of par 4,000,000 Retained earnings 2,000,000 Total stockholders’ equity $6,400,000 The insignificant effect of the stock split on the firm’s books is obvious.
reverse stock split
A method used to raise the
market price of a firm’s stock by
exchanging a certain number of
outstanding shares for one new
share. Stock can be split in any way desired. Sometimes a reverse stock split is
made: A certain number of outstanding shares are exchanged for one new share.
For example, in a 1-for-3 split, one new share is exchanged for three old shares.
Reverse stock splits are initiated to raise the market price of a firm’s stock when it
is selling at too low a price to appear respectable.9 Stock Repurchases
The repurchase by the firm of
outstanding common stock in the
marketplace; desired effects of
stock repurchases are that they
either enhance shareholder
value or help to discourage an
unfriendly takeover. In recent years, firms have increased their repurchasing of outstanding common
stock in the marketplace. The practical motives for stock repurchases include
obtaining shares to be used in acquisitions, having shares available for employee
stock option plans, and retiring shares. The recent increase in frequency and
importance of stock repurchases is due to the fact that they either enhance
shareholder value or help to discourage an unfriendly takeover. Stock repurchases enhance shareholder value by (1) reducing the number of shares outstanding and thereby raising earnings per share, (2) sending a positive signal to
investors in the marketplace that management believes that the stock is undervalued, and (3) providing a temporary floor for the stock price,...
View Full Document