Question

When Crocs, the shoe company, reported in early 2007 that its first-quarter earnings had increased from the previous year, its stock price jumped to over $80 per share. At the same time, the company announced a 2-for-1 stock split.. What is a stock split and what effect does it have on the company’s stockholders’ equity? What effect will it likely have on the market value of the company’s stock? In light of your answers, do you think the stock split is positive for the company and for its stockholders?

Answer 1

Solution:

Stock split means increasing the number of shares that are outstanding by issuing more shares to current shareholders.

In a 2-for-1 stock split, an additional share is given for each share held by a shareholder.

There is no change in overall stock holder's equity as no new captial was generated through stock split only par value of existing stock get reduced.

Market price of share affected due to stock split. After a split, the stock price will be reduced since the number of shares outstanding has increased.

The objective for stock split is to make shares seem more affordable to small investors even though the underlying value of the company has not changed. This has the practical effect of increasing liquidity in the stock.

Stock split may also result in a share price increase following a decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock. Another reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing and people assume this growth will continue in the future, and again, lift demand and prices.

From stockholder's point of view, stock split is also positive as some time after stock split share price is decreased but it is not decreased in the same proportion of stock split and hence will result in overall benefit to stockholders.