Stock Splits and When-Issued Trading: A Test of the Signaling Theory
Kemerer, Kevin L., Academy of Accounting and Financial Studies Journal
This study investigates empirically the presence/absence of when-issued trading in a sample of firms announcing stock splits in 2005 and 2006. The findings indicate that the operational performance of when-issued traded and non-when-issued traded firms differs prior to and after the stock split announcement. When-issued traded firms outperform when-issued traded firms with respect to EPS and ROTC after the stock split announcement suggesting that the existence of when-issued trading might be useful in identifying the better performing firms. Thus, the firms trying to mimic the signal of those firms with better future expectations may be recognized by investors and the opportunity to trade those shares on a when-issued basis may be foregone.
"When, as and if issued" (when-issued) trading is the trading in securities of certain unissued, but authorized, stock distributions. When-issued trading often exists because investors decide to sell the post stock split shares before they are issued. However, casual observation reveals that there are instances of stock splits that are not preceded by when-issued trading activity, although such trading is permitted. The relationship between when-issued trading and stock splits is not clear; thus, this relationship is the subject of this examination.
When-issued trading associated with stock splits appears to be a response by investors to the stock split announcement. After the announcement, investors may trade the securities of the stocksplitting firm on a "when-issued" basis or the "regular way".
For example, a shareholder owns one share of a firm's stock that is being traded at $50. If a two-for-one stock split is declared, the shareholder may 1) trade, on a when-issued basis, the two shares that will be issued, theoretically for $25 each (2x$25=$50), or 2) trade the original share on a "regular way" basis for $50. "Regular way" trading involves the purchase and sale of shares of stock under a contract that is settled on the fifth business day after the date of the trade. Contracts for the purchase and sale of shares on a when-issued basis are made in the same manner as regular way contracts, except that when-issued contracts are settled ordinarily by delivery and payment of the shares on the sixth business day after mailing of the newly issued shares.
How investors choose whether to trade on a regular or when-issued basis is unknown, but this differential reaction to stock split announcements might be evidence that investors do not interpret stock split announcements in a homogeneous fashion. The fact that investors choose not to trade some future distributions "when issued" suggests that investors recognize something different about these firms as compared to those firms whose securities are traded when-issued. This differential reaction may be important in addressing questions concerning stock splits, such as why they exist and why positive abnormal returns typically are associated with stock split announcements.
The current study investigates the differential reaction to stock split announcements demonstrated by the absence of when-issued trading in some cases. The operational performance and other characteristics of when-issued traded and non-when-issued traded firms are compared. The findings indicate that the operational performance of when-issued traded and non-when-issued traded firms does differ somewhat prior to and after the stock split announcement.
When-issued trading occurs when two parties reach a contractual agreement for the sale and purchase of shares that will be issued in the future (when-issued shares). The New York Stock Exchange (NYSE) justifies when-issued trading as follows:
In the case of a stock distribution which is substantial, both in percentage and in number of shares, the Exchange considers it desirable from the standpoint of public interest to afford shareholders who will receive the distribution the facilities of the Exchange market for their shares at the earliest possible moment. …