Journal of Modern Accounting and Auditing, ISSN 1548-6583 March 2012, Vol. 8, No. 3, 374-380
A Study on the Behavior of Large Stock Dividends and Stock
Splits Among Chinese Listed Companies: A Case Study on
Zoomlion’s 2010 Middle-Term Stock Dividend Plan
Qi Yongjun
Three Gorges University, China
This paper takes Zoomlion (Changsha Zoomlion Heavy Industry Science and Technology Development Co., Ltd) as an example and illustrates the reasons why traditional theories of stock dividends and stock splits cannot rationally explain the large stock dividend and stock split behavior among Chinese listed companies. The paper offers the following points after analyzing the current situation of China’s capital market: As many investors seek after the stocks with large stock dividends and stock splits and form a “herd effect”, it greatly pushes up the price of these stocks. Thus, companies’ managers can cater these investors’ irrational behavior, and help their companies get more funds from secondary equity offerings, or help their large shareholders and institutional investors to obtain more returns after lifting the sell restriction on their shares.
Keywords: large stock dividend and stock split, herd effect, catering theory
Introduction
Over the past decades, stock dividends and stock splits have always been the common distribution ways among Chinese listed companies, which is extremely rare in other countries. In Zoomlion (Changsha Zoomlion Heavy Industry Science and Technology Development Co., Ltd) mid-2010 distribution plan, it was disclosed that Zoomlion will distribute 15 shares and ￥1.7 for every 10 shares, creating a new record of “bonus shares” among Chinese listed companies. Stock dividends only transfer “retained earnings” account into “capital” account among shareholders’ equity, but each shareholder’s ownership percentage will not change because of the distribution of stock dividends. So that does not have any economic meaning for shareholders. In addition, Zoomlion’s mid-2010 distribution plan made its shareholders almost get nothing after paying high personal income tax (￥0.03 per 10 shares after paying personal income tax), since shareholders must pay 10% of the personal income tax for the stock dividends according to the face value of ￥1 per share at present in China. Although this distribution plan damaged shareholders’ wealth from economic perspective, many investors welcomed it withgreat enthusiasm. On the day of public announcement of Zoomlion’s mid-2010 distribution plan, its stock price was closed at daily rising limit. The stock price continued rising in the following months. There were some ingredients of Zoomlion’s financial performance to support its stock’s huge abnormal return on the market, but the most important factor was that many investors sought after the stocks with large stock
Qi Yongjun, Ph.D., associate professor, College of Economics and Management, Three Gorges University.
DAVID PUBLISHING
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dividends and stock splits and form a “herding effect”, and Zoomlion’s managers timely catered these investors’ irrational behavior and pushed up its share price. This not only made the company raise more funds from its subsequent HKEx listing, but also made the institutional investors who participated in the company’s private placement before get more profits after lifting the sell restriction in their shares. This paper will take Zoomlion’s mid-2010 distribution plan as an example and illustrate the behavior of large stock dividends and stock splits among Chinese listed companies.
Zoomlion’s Mid-2010 Distribution Plan and Its Stock’s Market Performance
Zoomlion was first listed in the Shenzhen Stock Exchange in October 2000, and its stock code is 000157. It is a company primarily engaged in development, manufacture, distribution, and leasing of heavy industrial equipment. The company provides concrete machines, hoist machines, road machines, and environmental machines, including truck-mounted concrete pumps, concrete mixing plants, truck-mounted concrete mixers, truck cranes, tower cranes, graders, road rollers, pavers, road sweepers, washing vehicles, back-feeding compression transfer vehicles, snow removals, bulldozers, excavators, fire trucks, and aerial working platforms. The company disclosed its 2010 second interim meeting resolution of the third Board on July 7, 2010: In order to return its investors, the company sent 15 shares as bonus shares and ￥1.7 cash dividends (including tax) for every 10 shares based on its total share capital of 1,971,054,705 shares on June 30, 2010. With this news, the company also announced that its profit would be greatly increased and it would issue H-stock that year.
After releasing this large stock dividend news, the company’s share price went all the way up. Taking into account that some investors may capture this news before its publication through various channels, the paper took its stock’s closing price on June 30, 2010 as the base, and analyzed its two-month stock price changes from July 1, 2010 to August 31, 2010. In addition, in order to make its stock price after the distribution of the stock dividends and cash dividends comparable with the price before the distribution, backward adjustment for its ex-right price from August 27 to August 31, 2010 was made. Lastly, in order to compare its stock price changes relative to the performance of SSECI (Shenzhen Stock Exchange Component Index) before and after Zoomlion’s publication of its large stock dividends plan, the cumulative return of SSECI and the cumulative abnormal return of Zoomlion’s stock price during this period were analyzed too. The calculation process of Zoomlion’s cumulative abnormal return is following:
Zoomlion’s cumulative abnormal return = The Cumulative changing percentage of Zoomlion’s stock price – The Cumulative changing percentage of SSECI.
Table 1 displays the cumulative price changes and the cumulative abnormal return of Zoomlion’s stock before and after the publication and implementation of its mid-2010 distribution plan. As can be seen from the table, its stock price was closed at daily rising limit, and its cumulative abnormal return reached 14.89%, relative to SSECI on the day of July 7, 2010 when Zoomlion announced its large stock dividends plan. After the announcement, the company’s stock price continued rising in the two following months. To the ex-dividend date of August 27, 2010, its cumulative return reached 51.82%, and its cumulative abnormal return reached 36.50% compared with SSECI. On August 31, 2010, its cumulative return reached 69.05%, and its cumulative abnormal return reached 48.25% relative to SSECI.
Table 1
The Price Changes of Zoomlion’s Stock Before and After Its Publication of Mid-2010 Distribution Plan
Important dates Closing day: Jun. 30 Pub. day: Jul. 7 Ex-right day: Aug. 27 Closing day: Aug. 31
Stock price 16.25 18.84 9.80 10.92
Price after adjustment -- -- 24.67 27.47
Day change % -- 9.98 -1.28 9.97
Cumulative change % -- 15.94 51.82 69.05
Cum. cha. % of SSECI -- 1.05 17.55 20.79
Cum. abnormal return (%) -- 14.89 34.27 48.25
Note. Source: Organized from Wind Finance and Securities Database.
Figure 1 more vividly displays the cumulative price changes of Zoomlion’s stock, the cumulative changes of SSECI, and the cumulative abnormal return of Zoomlion’s stock relative to SSECI before and after the publication and implementation of its mid-2010 distribution plan. It should be explained that, because Zoomlion’s stock exchange suspended on July 22, 2010 due to its holding of its First Extraordinary General Meeting of Shareholders in 2010, the data of SSECI on that day in Figure 1 was removed, in order to make it comparable with Zoomlion’s data. After the above treatment, Figure 1 shows the closing data of the remaining 43 days from July 1 to August 31, 2010 which use the closing data of June 30, 2010 as their bases.
Figure 1. The price changes of Zoomlion’s stock before and after its publication and implementation of Mid-2010 distribution plan.
Traditional Explanation for Large Stock Dividends and Stock Splits
Both large stock dividends and stock splits will result in substantial increases in the number of shares outstanding and significant drops in the stock prices, but each shareholder’s ownership percentage and total equity of these companies will remain unchanged (because Chinese investors are required to pay 10% of personal income tax for stocks received from stock dividends according to the face value of ￥1 per share,
-10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 Zoomlion cumulative change (%) SSECI cumulative change (%) Zoomlion’s cum. Abn. return (%)
stock dividends actually reduce the wealth of each shareholder who receives the stock dividends, but the amount is negligible relative to the stock prices of these companies, so the paper does not take account of this amount in this paper for the sake of simplicity). The paper will take Zoomlion as an example to explore whether the traditional theories of stock dividends and stock splits are applicable for the behavior of large stock dividends and stock splits among Chinese listed companies.
Signaling Hypothesis
According to signaling hypothesis, there is information asymmetry between outside investors and the managers of the listed companies, and the managers may have some information that outside investors did not know. Stock dividends and stock splits convey the information that the managers believes that their companies’ stock price will rise because their profit will increase in the future. This causes these companies’ stock price going up after the investors correctly understand this signal. In the U.S., the cumulative abnormal return is less than 5% on average before and after companies’ announcement of stock dividends and stock splits, and companies’ managers are very cautious when they announce the plan of stock dividends and stock splits.
In China, large stock dividends and stock splits do not convey any information, and it is a common practice of listed companies. Some companies give large stock dividends and stock splits to investors after they occurred a significant decline in performance (for example, Zhejiang Wynca Chemical Industry Group Co., Ltd., stock code is 600596, disclosed its 2010 Annual Report on March 26, 2010), or even after they occurred a loss (for example, Danhua Chemical Technology Co., Ltd., stock code is 600844, disclosed its 2010 Annual Report on February 26, 2010). In addition, the cumulative abnormal return of large stock dividends and stock splits is greater than 30% on most occasions, well above the average in the U.S. To Zoomlion, both Figure 1 and Table 1 show that the stock’s cumulative return is nearly 70%, and its cumulative abnormal return is nearly 50% relative to SSECI in the two months before and after its announcement of its large stock dividends plan. Thus, signaling theory cannot satisfactorily explain the behavior of large stock dividends and stock splits among Chinese listed companies: Firstly, the theory cannot explain the unusually cumulative abnormal return of large stock dividends and stock splits companies; secondly, the theory cannot explain the behavior of large stock dividends and stock splits among those companies with poor performance or at a loss.
Liquidity and Transaction Boundary Hypothesis
According to liquidity and transaction boundary hypothesis (Lakonishok & Lev, 1987), most investors fear high-priced stocks, or they cannot afford high-priced stocks due to their limited funds. Through stock dividends and stock splits, companies can reduce the prices of their stocks to a reasonable trading range to attract more investors, thus improving the liquidity of their stocks. However, this hypothesis has not been supported by empirical evidence in the United States (Lipson & Mortal, 2006). It also cannot satisfactorily explain the behavior of large stock dividends and stock splits among Chinese listed companies.
Let us check the situation of Zoomlion’s. Its average stock price is ￥16.44 in the five trading days before announcing its large stock dividends, and the majority of investors who are willing to buy the stocks of this company have the ability to buy more than one lot (100 shares) of its stock at this price. Obviously, the transaction boundary theory cannot reasonably explain its large stock dividend behavior. Its stock price dropped to ￥9.80 on the ex-right day of August 27, 2010, but its investors still need to buy several lots to save transaction costs because security institutions charge at least ￥5 on each transaction. Therefore, for the
company such as Zoomlion whose stock price is not high, it does not need to adopt large stock dividend and stock split plan to increase its stock’s liquidity.
In addition, security institutions, insurance companies, investment funds and other institutional investors have enough funds to invest any high-priced stocks which have investing value. Even if these companies do not adopt large stock dividend and stock split plan to reduce their stock’s price, they will still invest in their stocks. Therefore, their stocks should not have much cumulative abnormal return even large stock dividends and stock splits do increase their stocks’ liquidity. But in China, the situation is very different. Stocks adopting large stock dividend and stock split plan usually can get 30% cumulative abnormal return, which is rare in other countries. Zoomlion’s cumulative abnormal return is even close to 50% in the two months before and after its announcing large stock dividend plan.
Further Exploring on the Behavior of Large Stock Dividends and Stock Splits
Because traditional theories of stock dividends and stock splits cannot reasonably explain the large stock dividend and stock split behavior among Chinese listed companies, the paper will take a different perspective based on behavioral corporate finance: Firstly, as many investors irrationally seek after the stocks with large stock dividends and stock splits, they form a “herd effect” and greatly increase the prices of these stocks. Secondly, some rational managers among Chinese listed companies timely cater these investors with large stock dividends and stock splits, thus increasing the prices of their stocks. Zoomlion is taken as an example again here to illustrate the above two aspects.
The Herd Behavior Among Investors
Herd behavior refers to the tendency for individuals to mimic the actions (rational or irrational) of a larger group. Because the history of Chinese capital market is very short, there are many immature investors who are lack of the fundamental knowledge to understand real meaning of some accounting handling ways. Large stock dividends, and stock splits make these people feel that they are getting more wealth, thereby competing to buy such stocks and push up the prices of those stocks in a short time. The increase of the stock prices forms a positive feedback effect and further strengthens the confidence of those investors, which in turn attract more investors to participate in and engender a “herd effect”. Take Zoomlion as an example, its stock price was closed at daily rising limit after it announced its mid-2010 distribution plan of sending 15 shares of stock dividend and ￥1.7 of cash dividend for every 10 shares on July 7, 2010. This was the result of many investors pursuing stocks with large stock dividends and stock splits. In the following 40 trading days, this “herd effect” continued to spread and the company’s stock price rose another 50%.
In addition, major financial media and security analysts’ recommendations further contribute the “herd effect” for stocks with large stock dividend and stock split plans. Take Zoomlion as an example, on the day of its announcing the mid-2010 distribution plan, some famous Chinese financial webs such as eastmoney.com, hexun.com reported or reproduced this news with the title “Beginning the first shot of large stock dividends and stock splits, Zoomlion will send 15 shares of stock dividend for every 10 shares.” A few days later, major financial media reported it again with another title “Zoomlion’s stock price continues surging and a new uptrend of large stock dividends and stock splits is beginning.” Many security analysts also recommended its stock with “buys” rate. Such continuous coverage and analysts’ improved rating further stimulated the investors’ herd behavior and pushed up the stock price of Zoomlion.
The Managers’ Timely Catering
Large stock dividends and stock splits are only an internal structural adjustment in shareholders’ equity which does not have any impact on companies’ profitability and the return of shareholders’ equity, but some investors enthusiastically seek after those stocks. This makes companies’ managers more convenient in arranging for some important financial matters such as secondary equity offering. Companies’ managers can simply cater these investors’ irrational behavior with large stock dividends and stock splits to increase their stocks’ prices (Baker & Wurgler, 2004; Baker, Greenwood, & Wurgler, 2009). Then, they can get more funds from secondary equity offerings, or make large shareholders and institutional investors to obtain higher returns after lifting the sell restriction in their shares.
Take Zoomlion as an example, its managers chose this time to announce its large stock dividends plan mainly for two reasons. The first one is to push up its stock price by catering investors’ irrational need for large stock dividends and stock splits, and get more funds from its subsequent HKEx listing. After carrying out its large stock dividend plan, Zoomlion issued 869,582,800 shares of common stock at the price of HK$14.98 per share on the days between December 13 and 16, 2010, accounting for 15% of the company’s total shares. Later, because international underwriters such as China International Capital Corp., Goldman Sachs Group Inc., JPMorgan Chase & Co., and Morgan Stanley who managed the offering exercised over-allotment option in full on January 5, 2011, the company issued 1,000,020,200 shares of H-stock in total, representing 16.9% of the company’s total shares, raising a total capital of HK$15 billion, equivalent to about Chinese ￥12.8 billion.
If Zoomlion had not carried out its large stock dividend plan and maintained the issuing ratio of H-stocks unchanged, the number of shares issued in HKEx should be 400,008,080 shares. We could further assume that the closing price of ￥17.13 on July 6, 2010 (the day before Zoomlion announced its mid-2010 distribution plan) would become its reference price for its H-stock. Then, the company could only raise ￥68.5 billion, equivalent to about HK$80 billion which is just about 53.5% of the actual funds the company has raised. Zoomlion successfully used large stock dividend plan to push up the price of its A-stock, thus also pushing up its issuing price of corresponding H-stock, and raised more funds.
The second reason for Zoomlion’s pushing up its stock price with large stock dividends was to make institutional investors who participated in the company’s private placement to get more returns after lifting the sell restriction in their shares. Institutional investors who participated in private placement generously gave the funds to the companies when they were most in need of them, and they made important contributions to these companies’ healthy development. So the companies’ managers would gladly meet their demands should they ask for large stock dividends and stock splits.
Take Zoomlion as an example, it issued 297,954,705 shares of A-stock to nine institutional investors on a private placement at the offering price of ￥18.70 on January 28, 2010. These institutional investors were at a loss on the day before the company’s announcing its large stock dividend plan. Their shares became to 744,886,762 shares after the company sent out its stock dividends, and the price of its stock also greatly increased. The stock price was closed at ￥14.23 on the day of February 14, 2011 when the sell restrictions on their shares were lifted. The book profit of these nine institutional investors amounted to￥5 billion and the return of their investment amounted to 90% after only one year.
Conclusions
After analyzing Zoomlion’s large stock dividend plan, we can see that the purposes of stock dividends and stock splits among Chinese companies are completely different from that of some western countries such as the U.S. So the traditional theories of stock dividends and stock splits such as signaling hypothesis, or liquidity and transaction boundary hypothesis cannot reasonably explain the behavior of large stock dividends and stock splits among Chinese listed companies, and the following huge abnormal return accompanying this behavior. Considering the weak explaining ability of these theories, this paper takes a perspective of behavioral corporate finance to make up their defects, and offer the following opinions illustrate this phenomenon:
(1) As many investors seek after the stocks with large stock dividend and stock split and form a “herd effect”, this can greatly push up the price of these stocks;
(2) Companies’ managers can choose a right time to cater these investors’ irrational behavior and meet their needs with large stock dividends and stock splits, then, they can help their companies get more funds from secondary equity offerings, or help their large shareholders and institutional investors to obtain more returns after lifting the sell restriction on their shares.
References
Baker, M., & Wurgler, J. (2004). A catering theory of dividends. Journal of Finance, 59, 1125-1165.
Baker, M., Greenwood, R., & Wurgler, J. (2009). Catering through nominal share prices. Journal of Finance, 64, 2559-2590. Lakonishok, J., & Lev, B. (1987). Stock splits and stock dividends: Why, who and when. Journal of Finance, 42, 913-932. Lipson, M., & Mortal, S. (2006). The effect of stock splits on clientele, is tick size relevant. Journal of Corporate Finance, 12,
