Liquidity changes around Bonus issue announcement ... - SSRN papers

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Abstract. This study examines share price reaction to the announcement of Bonus Issue for a sample of. Indian Companies. Standard event study methodology ...

STOCK MARKET REACTION AND LIQUIDITY CHANGES AROUND BONUS ISSUE ANNOUNCEMENT: EVIDENCE FROM INDIA Ms. Madhuri Malhotra1, Dr. M. Thenmozhi2 & Dr. G. Arun Kumar3 Abstract This study examines share price reaction to the announcement of Bonus Issue for a sample of Indian Companies. Standard event study methodology has been used for the purpose of studying the Bonus issue announcement reaction. Bonus issue announcement yields negative abnormal returns around the announcement date. There is a negative reaction after the bonus issue announcement conveying that the market underreacts after the announcement. It is also observed that there is no information leakage prior to the announcement. Reduction in the liquidity ratio after the announcement is evidenced, though insignificant. All the three liquidity measures seem to be inconsistent with the enhanced trading liquidity expectation. Cross sectional regression shows that the number of shares issued, convey a positive signal to the investors. Further it has been evidenced that the size of the firm issuing bonus shares does not affect the abnormal returns of the company. The study supports Signaling Hypothesis and Cash Substitution Hypothesis. Key words: Event study, Stock dividend, Liquidity, Stock market, Cross Sectional Regression JEL Classification: G14, G32

SECTION 1: INTRODUCTION Bonus issues are simply distribution of additional stocks to the existing shareholders. It is a “free” issue of shares, without a subscription price, made to existing shareholders in proportion to their current investment. A firm can distribute bonus shares by using retained earnings or accumulated capital reserves. The relationship between Bonus issues and share prices has been the subject of much empirical discussion within the finance literature. Empirical research (particularly in US) has shown that the market generally reacts positively to the announcement of a bonus issue. The hypothesis that has received strongest support in explaining the positive market reaction to bonus issue announcements is the signaling hypothesis, which suggests that ‘the announcement of a bonus issue conveys new information to the market in instances where managers have asymmetric information’. This hypothesis has received almost unequivocal support with few exceptions (for example, Papaioannou, Travlos and Tsangarakis (2002). As per the signaling hypothesis, the declarations of bonus issues convey favorable private information about the future earnings to the investors. Managers have superior information about the future earnings, because there may be asymmetric information between managers and investors. Miller and Modigliani (1961) demonstrated theoretically that bonus issues, along with other types of dividends, do not alter shareholder wealth. If a company plans to finance a bonus issue from retained earnings, it makes a book entry to allocate retained earnings into paid-up capital in the shareholders’ equity section of the company balance sheet. Alternatively, a company that decides to realize a bonus issue by using accumulated capital reserves adjusts the accumulated capital reserves into paid-up capital. The company does not receive any cash and its financial position remains the same. The modification triggered by the bonus issue is that the number of outstanding shares is adjusted by the bonus issue ratio, therefore, the price of the shares declines according to the same bonus issue ratio. The total market value of the shares or the value of the shares that are held by each investor should remain unchanged. Sloan (1987) provided Australian evidence that bonus issues do not affect shareholders’ wealth. In practice, however, there may be an increase in share price following the announcement of a bonus issue. Such an increase can occur because the announcement of a bonus issue may have beneficial informational content (Peterson 1971). Shareholders are aware that, after the bonus issue, companies usually increase total dividend payout. This, in turn, indicates the confidence of management in the

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Indian Institute of Technology Madras, Email: [email protected] Indian Institute of Technology Madras, Email: [email protected] 3 Indian Institute of Technology Madras, Email: [email protected] 2

1 Electronic copy of this paper is available at: http://ssrn.com/abstract=962830

company’s future. Consequently, the share price may increase in response to this information and affect shareholders’ wealth. The informational link between dividends and earnings is supported empirically by Healy and Palepu (1988). They show that firms that initiate dividends have significant increases in earnings for at least one year after the announcement. Stock splits in the U.S. and in other markets are associated with positive market reaction around the announcement day (e.g., Lamoureux and Poon, 1987; Ikenberry et al., 1996). One of the explanations for the positive market reaction is the expected increase in trading liquidity following stock splits. However, the empirical evidence on the trading liquidity effect is not convincing and empirical results show contrary evidence (Copeland, 1979; Lakonishok and Lev (1987) Conroy et al. (1990). McNichols and Dravid (1990) provided further evidence to support the signaling hypothesis by examining the relationship between the size of a stock dividend (or split factor) and the degree of abnormal returns around the announcement dates. Their findings suggested a positive relationship between stock dividend size and abnormal return; that is, the larger the stock dividend, the greater the signaling benefits. However, a study in U.S. by Papaioannou et al. (2000) analyzing price reaction to stock dividend announcements by firms listed on the Athens Stock Exchange found no statistically significant abnormal returns on and around the announcement date. The results of this research can be explained by the fact that most stock dividend distributions are compulsory requirements imposed upon the firms to satisfy regulatory requirements and shareholder approval must be sought regarding the size and terms of the distributions. Stock dividend announcements in Greece are almost fully anticipated by the market and do not contain any new information; thus, they have little signaling benefit. However, a Canadian study by Masse et al. (1997), investigating the impact of stock dividend announcements on the value of firms listed on the Toronto Stock Exchange, found significant and positive abnormal returns around the announcement date. Foster and Vickrey (1978) were among the earliest to examine the signaling hypothesis using daily returns data and in their examination of the information content of 82 stock dividend announcements, they found significant positive abnormal returns around announcement dates. Balachandran et. al. (2004), examines share price reaction of the announcement of Bonus share issues for a sample of Australian companies over the period 1992-2000. They found that bonus issue announcement leads to a statistically significant positive price reaction. They provide evidence in support of signaling hypothesis consistent with the findings in the United States, Sweden, Canada and New Zealand. However, this study qualifies this result by suggesting that the signaling effect is stronger for industrial non-financial and mining companies than for financial companies. Liquidity refers to the ease of converting assets into cash at minimal costs. Grinblatt, Masulis and Titman (1984) provide empirical evidence indicating that stock prices, on average, react positively to stock dividend and stock split announcements. Lakonishok and Lev (1987) analyze the behavior of two major indicators of corporate performance: growth in earnings and in cash dividends. Lankanishok and Lev (1987) investigated Liquidity Hypothesis, which suggests that stock dividend announcements are intended to improve liquidity, as the creation of additional stocks should lead to an increase in trading and greater ownership dispersion in a firm. Denis and Kadlec (1994) report that there is a significantly positive change in liquidity (measured by the turnover ratio) between the 250-day periods preceding and following a seasoned equity offering. Another study by Eckbo et al. (2000) also documents a significant increase in liquidity for the 5-year period after issues of seasoned common stock. Therefore, liquidity is valuable to investors. Several studies such as Amihud and Mendelson (1986), and Datar et al. (1998) report that liquidity helps explain the cross-sectional variation of stock returns. Evidence of a positive and significant link between liquidity improvements and stock price adjustments is also documented by Beneish and Whaley (1996), and Lynch and Mendenhall (1997) (hen securities are announced to be added to S&P 500 list), and by Elyasiani et al. (2000) (when a stock is transferred from NASDAQ to NYSE and AMEX). Lakonishok and Lev (1987) investigated the liquidity hypothesis by examining trading volume changes after stock dividend announcement and found that trading volume did not increase as a result of stock dividends. They analysed the characteristics of the firm that had stock dividends in comparison to the corresponding characteristics of firms without stock dividends. They found that (a) there is no significant difference in the prices between the two groups; (b) there are no differences in marketability before or after the distribution of stock dividends.

2 Electronic copy of this paper is available at: http://ssrn.com/abstract=962830

A hypothesis that has received far less support is the liquidity hypothesis, which suggests that stock dividend announcements are intended to improve liquidity, as the creation of additional shares should lead to an increase in trading and greater ownership dispersion in a firm. Lakonishok and Lev (1987) investigated this hypothesis by examining trading volume changes after stock dividend announcements and found that trading volume did not increase as a result of stock dividends. Ho et. al. (2002) examined whether there is any liquidity change between the pre issue period and the post issue period of Seasoned Equity offerings using data from Taiwan market. They find that there is a statistically significant increase in liquidity (measured by number of shares traded divided by number of shares outstanding) when firms make seasoned equity offerings. Furthermore, the liquidity enhancement appears to bear no significant connection with the issuing size, the issuing price, and the market value of the issuing firm. Grinblatt et al. (1984) proposed an alternative form of the signaling hypothesis to justify positive market reaction to stock dividend announcements. They suggested that managers use stock dividends to attract attention from professional analysts and to trigger a revaluation of their future cash flows, which they termed as the attention-getting hypothesis. Doran and Nachtmann (1988) examined the attention getting hypothesis using a sample of 879 firms which issued stock dividends and 898 firms that announced stock splits between 1971 and 1982. Their examination of analyst’s earnings forecasts found that immediately after the announcement of a stock dividend there was a significant positive revision in earnings expectations, which they interpreted as support for the attention getting hypothesis. In our study we found that the Cumulative abnormal returns decline after the bonus issue announcement which is not in line with the attention getting hypothesis. Investors may also feel that firms can conserve cash by issuing a stock dividend as a temporary substitute for an existing or contemplated cash dividend. Ghosh and Woolridge (1988) found that negative share price reaction to dividend cuts and omissions could be offset or lessened by an announcement of a stock dividend as a substitute. This finding lends support to the cash substitution hypothesis, which suggests that firms can conserve cash by issuing a stock dividend as a temporary substitute for an existing or contemplated cash dividend. Banker, Das, and Datar (1993) investigated the cash substitution hypothesis by examining the market reaction to firms who announced they were discontinuing cash dividends, but maintaining an existing level of stock dividends. They found a positive (although statistically insignificant) abnormal return followed these announcements. Banker, Das, and Datar also found that firms with no prior stock dividend history who announced that they were discontinuing cash dividends experienced significantly negative share price reactions, supporting the cash substitution hypothesis In India, Ramachandran (1985) examined the impact of announcement of bonus issues on equity stock prices and found mixed evidence for semi strong form efficiency of Indian stock market. Rao and Geetha (1996) analyzed bonus announcements and concluded that one could not make excess money in the stock market by studying that patterns of abnormal returns of announcements made earlier. Rao (1994) document positive stock market reaction to equity bonus announcement. He estimated cumulative abnormal return of 6.31% around the three days of bonus announcement Mohanty (1999) finds that most of the companies either keep the same dividend rate after the bonus payment or decrease it less than proportionately (after considering bonus payment) and thereby increases the cash flows to the shareholders. Asim Mishra (2003) found appositive cumulative abnormal return around the bonus issue announcement. Obaidullah. Srinivasan (2002) found extremely large positive abnormal returns on exbonus and ex-rights days for equity stocks. Similar study by Budhraja et al. (2004) on BSE suggests that abnormal returns in stock prices around the bonus announcement date over a three day trading period starting one day before the announcement date is significant at 95% confidence limit. It also says that much of the information in the bonus announcement gets impounded into stocks by the time of announcement. Thus, there is evidence of positive reaction to stock dividend (Peterson (1971), Healy Palepu (1988), Lamoureax and Poon (1987), Ikenbery et al.(1996), Mc Nichols and Dravid (1990), and Masse et al. (1997) while Papaioannou et al. (2002), has found the reaction to be negative. In the Indian context, Rao (1994), Asim Mishra (2003), Obaidullah and Srinivasan (2002), Budhraja et. al. (2004) support positive reaction to bonus issue announcement. Thus, there is mixed evidence as to the effect of stock market

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reaction to bonus issue announcement. Similarly, a review of studies examining the liquidity changes around bonus issue announcement provide evidence of mixed results. Grinbalatt, Masulis and Titman (1984). Denis Kadlec (1994), Eckbo et al. (2000), Beneish and whaley (1996), Lynch and Mendenhall (1997) support liquidity hypothesis, while Copeland(1979),Lakanishok and Lev (1987), Conroy et al. (1990) support attention getting hypothesis. Ghosh and Woolridge (1988) support cash substitution hypothesis. Moreover, not much attempt has been made to examine the liquidity change around bonus issue announcement in emerging markets and the existing literature do not provide any clear evidence of the effect. Though most of the studies have looked into the changes in abnormal returns and cumulative abnormal returns, very few authors (Ho et. al, and Adouglu (2005) have extended the study to identify whether the size of the bonus issue, the market value of firm, book to market ratio and the pre cumulative abnormal returns contribute to the abnormal returns observed around bonus issue announcement. the Issue of bonus shares being a popular and frequently used mechanism to signal performance of the companies, it is pertinent to understand the impact of such issues on the stock market both in terms of change in returns and change in liquidity in an emerging market like India. Hence, in this paper the stock market reaction around bonus issue announcement has been examined in terms of changes in cumulative abnormal returns and changes in liquidity and an attempt has been made to identify the critical variables that would have caused changes in cumulative abnormal returns. Keeping in view that the reaction of Bonus issue announcement may vary according to the nature of a particular industry, the study has been done with specific reference to bonus issue announcement in the Chemical Industry. The paper is organized as follows. Section two outlines the research design and methodology employed in this paper. Section three discusses the price reaction results, liquidity enhancement tests results and the outcome of cross-sectional regression. Section four summarizes the results and concludes. SECTION 2: DATA AND METHODOLOGY We identified the bonus issues made by Bombay Stock Exchange listed Chemical firms during 2000-2006 from the Prowess 2 database of Centre for Monitoring India Economy (CMIE). Extreme cases had been removed where bonus ratio is greater than 5:1 (five for one) or the insignificant issues where the ratio is less than 1:4 (one for four). In case of firms with multiple bonus issues we have included other issues only if it is occurring after four years. Finally we excluded firms that do not have financial results for previous financial year in relation to equity bonus distribution. In this process out of 44 firms, which have come up with bonus issue announcement, only 23 met the following criteria: 1. Bonus issue had to be an issue of new ordinary fully paid securities and not issued with a rights issue. 2. There should not be any cash dividend announcement along with the Bonus announcement. 2.1 Event Study Methodology The standard methodology is used to evaluate the reaction of share prices to public announcements is an event study, which was employed as early as 1933 by Dolley. Over the past half century, event studies have been employed in much research and their sophistication has been greatly improved by authors such as Fama et al. (1969) and Brown and Warner (1980, 1985).To construct an event study, the event, event window, estimation window, estimation model, and investigation window should be determined. The event is what the investigators would like to study, and it conveys information that potentially influences the stock prices. The events defined for this study are the announcements of bonus issue. An event window is the period in which an event occurs. The event window in this study is expressed as –1, 0, +1. The estimation window in this study is defined from the day –121 to the day –21 before the announcement date 0. In an event study, both the abnormal returns occurring during the time of the event window and the abnormal returns occurring in the periods around the event window must be investigated. The abnormal returns occurring in an interval before the event window reveal whether the market has anticipated the information contained in the event (or there has been trading on inside information). The abnormal returns in an interval after the event window can tell us whether the market overreacts or under reacts to the announcement of the event. The investigation window in this study is an extension of the event window, from day –20 through day +20. The selected examination model for this study is the market-adjusted model. The market-adjusted model is

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ri , t = r m , t + ε i , t where r i, t is the return of stock i at day t, r m, t is the market return at time t, as calculated from a market portfolio or a market index and ε i,t is the abnormal return of stock i at day t. Thus, the market-adjusted model assumes that the normal returns are equal across all stocks at time t, but not necessarily constant for a given security at different times. The abnormal return on any stock i is determined by the difference between its return and that on the market portfolio simultaneously,

ε = r −r i, t

i, t

m, t

Parametric t test has been used to test the significance of the abnormal returns. Regression analysis is used to estimate the relationship between a firm’s return and stock returns of a benchmark group. (Chemical Index provided by the Indian database PROWESS has been used for the purpose). The event window is taken as t=-20 to t=+20 relative to the event day t=0(date of announcement of Bonus) and the return is proxied on the market portfolio is proxied by the CMIE – Chemical Index (since Chemical companies have been analysed in this study. Return on security I in period t is given by:

Ri , t = In( Pit / pit − 1) The announcement effect on the stock price is measured by the Market adjusted model. Aggregation of the returns is done using CAR (Cumulative abnormal returns approach), where CAR is: 2

CAR(t1, t 2) = ∑ ARt t =t 1

2.2 Enhanced trading liquidity tests Theoretically, stock’s trading volume is an increasing function of its liquidity, ceteris paribus (Amihud and Mendelson, 1986). Therefore, an increase (decrease) in the trading volume shows an increase (decrease) in liquidity. Following Amihud et al. (1997), three different measures of liquidity, namely the stock’s raw and relative trading volume, and the stock’s liquidity ratio, are used in order to test the enhanced trading liquidity effect. The first two measures of liquidity are the average raw and relative daily trading volume in the periods before and after the announcement day. The change in raw trading volume (VOL) for security i is computed as:

VOLi = In(VOLi ) after − In(VOLi )before Where VOLi is the average daily trading volume in the periods before the announcement day (before) and after the announcement day respectively. The average trading volumes are calculated for the period (−120 to −21) before the announcement day and for the period (+21 to +120) after the announcement day. Similarly, taking into account the effect of market activity, the change in average daily relative trading volume (RELVOL) for security i is computed as: REL VOLi = In(VOLi / VOLm ) after − In(VOLi / VOLm) before where VOLi is the average trading volume of security i and VOLM is the average trading volume of the market in the periods before the announcement day and after the ex-rights day respectively. The second measure is the liquidity ratio which is also known as the Amivest measure of liquidity or the market depth ratio. Originally developed by Amivest corporation for its monthly newsletter, the liquidity ratio is considered as a good proxy for market depth in several microstructure studies (e.g., Khan and Baker, 1993; Muscarella and Piwowar, 2001). The liquidity ratio measures the trading volume associated with a unit change in the stock price. In other words, a high ratio indicates that investors can trade a large number of shares with little price change. Therefore, an increase (decrease) in the liquidity ratio shows an increase (decrease) in liquidity or market depth for a stock. The ratio is measured as:

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LRi

k ,m

∑ = ∑

m

k m k

Vi , t Ri , t

Where Vi, t and |Ri,t| are the trading volume and the absolute return, respectively, for stock i on day t, comparing the liquidity for the period (−120 to −21) before the announcement day to the liquidity for the period (+21 to +120) after the announcement day. The change in the liquidity ratio (LR) for security i is measured as:

LRi = In( LRi ) After − In( LRi ) Before These three measures (VOL, RELVOL and LR) are calculated for companies in the Chemical Industry announcing a bonus issue. The statistical significance of mean and median changes in VOL, RELVOL and LR is tested by using the parametric t-test . 2.3 Cross-sectional analysis of price reaction A cross-sectional regression model is used to examine the association between announcement period abnormal returns and a range of variables, which may have influenced this share price reaction. The dependent variable is the three-day abnormal return from day-1 to day + 1. The set of explanatory variables and the anticipated signs of their coefficients are outlined below. Bonus issue size (BON) : BON is the ratio of number of shares offered divided by the number of shares outstanding. The coefficient of this variable is expected to be positive . This variable helps one to see whether shareholders take into account the number of shares increased or not. The justification for including this variable as an explanatory variable is derived from the information content of bonus share option issues. The larger the size of the bonus share option issue, the greater information content. Therefore, a positive coefficient is anticipated. Pre Cumulative abnormal return (PRECAR) : PRECAR is the cumulative abnormal returns from 20 days prior to 2 days prior to the bonus issue announcement. If the market anticipates the revelation of information about the issue of bonus share options, investors will start bidding up the prices prior to the announcement date. The coefficient of this variable is expected to be negative since the greater the bidding up prior to the announcement the lower the magnitude of the price reaction on the announcement date. Market Value of the firm (LMV): LMV is the natural logarithm of the market value of the issuing company one month prior to the announcement date. It is anticipated that the coefficient of this variable will have a negative sign since smaller companies have greater information asymmetry and therefore the signaling effect of the bonus share option announcement will be greater than a comparable signal from larger companies. Book to Market Ratio (BM): This variable is the book-to-market ratio at the balance date immediately prior to the bonus share issue announcement. Book-to-market is defined as the book value of equity to the market value of equity. It is included in the regression as a control variable. It is documented by Fama and French (1992) and Barber and Lyon (1997) that high book-to-market firms earn greater average returns than low book-to-market firms. Therefore, a positive coefficient is expected for this variable. SECTION 3: EMPIRICAL RESULTS 3.1 Announcement market reaction The total portfolio consists of 24 Bonus issue announcements. The results of the tests on the announcement of bonus proposals are summarized in Table-1. Table-1, presents the Cumulative Abnormal Returns (CARs) of each portfolio around the announcement date of the bonus proposals. From the Table, it is evident that the CARs of all bonus proposals at dates +1 to +20 are negative and significant at 10% level of significance. Therefore, on an average, the bonus proposals raise negative CARs around the announcement date. Announcement of bonus proposals in Chemical Industry, on average, has a negative effect in India.

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Table 1, shows insignificant positive CARs in the intervals of dates –5 to +5 and -5 to -1, but shows positive CARs in the interval, +1 to +5, around the announcement date 0. The significantly negative CARs are generated mainly in the intervals of dates +1 to +5, +1 to +10 and +1 to +20 after the announcement date, suggesting underreaction to the unanticipated bad news. Meanwhile, significantly positive CARs are generated mainly in the intervals of –5 to –1, –10 to –1, and –20 to –1 before the announcement date implying that the market anticipated and incorporated the information before the event. Table 1. Parametric t-test statistics on the Cumulative abnormal returns for the Specific event Date 11 Days around Event Day Date -5 to -1 +1 to +5 -5 to +5

Market adjusted Model .195 -.053 .034

21 Days around Event Day Date

Market adjusted Model

-10 to -1 +1 to +10

.824 -2.137**

-10 to +10

-2.995***

41 Days around Event Day Date

Market adjusted Model

-20 to -1

1.623

+1 to +20

-2.200*

-20 to +20

-2.604**

Notes: 1. Date 0: event date, the date of the announcement. 2. Date -1: alternative event date, the announcement may occur one day in advance of that on record. 3. Date +1: alternative event date, the announcement may occur one day later than that on record. *,** If the t-test statistic is larger in absolute value than 1.96 or 2.58, the relevant abnormal return is statistically nonzero at the 5% or 1% significance level, respectively. 3.2 Enhanced trading liquidity test results Enhanced trading liquidity tests show that the mean changes in trading volume (VOL) and the mean and the mean and median change in relative trading volume (RELVOL) are negative but all are statistically insignificant according to parametric t test. According to the results shown in Table 2 both mean and median Relative Trading Volume(RELVOL)yield a negative result indicating a decline in liquidity, but this liquidity measure is also statistically insignificant. The coefficients of Liquidity ratio are negative, indicating reduction in liquidity after the bonus issue. The preceding results of the liquidity measures are insignificant according to parametric t test, thus these measures are inconsistent with the enhanced trading liquidity expectation. Table 2 : Changes in Liquidity

Mean(t statistic) Median Positive :Negative

VOL -0.04003(-.356) -0.15125 9:15

RELVOL -0.00368(.063) -0.15169 10:14

LR -2.40718(-.995) -0.15033 10:14

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The table shows three measures of the change in the liquidity of the companies undertaking Bonus issue comparing the liquidity for the before period (−120 to−21) relative to the announcement day to the liquidity for the after period (+21 to +120). The change in liquidity (VOL) is measured as ln(VOLi)after −ln(VOLi)before, whereVOLi is the daily trading volume for security i. Similarly, the change in relative liquidity (RELVOL) is measured as ln(VOLi/VOLM)after −ln(VOLi/VOLM)before, where VOL is the average daily trading volume for security i and VOLM is the average trading volume of the market. The change in the liquidity ratio (_LR) for security i is measured as ln(LRi)after −ln(LRi)before, where the liquidity ratio (LR) is measured as LRik ,m = ∑km Vi, t / ∑mk Ri, t where VOLi,t and |Ri,t| are the trading volume

and the absolute return respectively on stock i on day t. “Positive” and “negative” show the number of positive and negative changes respectively. 3.3 Cross sectional analysis of price reaction Cross sectional regression shows the association between cumulative abnormal return from one day prior to the announcement to one day after the announcement and the potential explanatory variables outlined above. The t statistics are given in parenthesis. As it can be seen in Table 3, the coefficient of BON is positive and significant at least at the 10% level. The results indicate that the announcement period abnormal returns are positively associated with the ratio of number of shares issued to the number of shares outstanding, indicating that shareholders take into account the total increase in the number of shares offered. This also means that the number of shares offered as bonus issue conveys positive information to uninformed investors consistent with the Heinkel and Schwartz (1986) model. PRECAR is the cumulative abnormal returns from 20 days prior to 2 days prior to the bonus issue announcement. Results show that PRECAR has a positive coefficient and is significant at 10 % level of significance. This implies that the market does not anticipate the revelation of information about the issue of bonus share options. The coefficient of this variable is positive while it was expected to be negative since the greater the bidding up prior to the announcement, the lower the magnitude of the price reaction on the announcement date. Thus one can conclude that there is no information leakage prior to the bonus issue announcement in the Chemical Industry in India. The coefficient of the variable LMV is negative as expected; LMV is the natural logarithm of the market value of the issuing company one month prior to the announcement date. The results show that the size of the company as measured by the market value of the company does not impact the abnormal returns of the company significantly. The coefficient of the control variable included in the regression model is positive as expected but it is insignificant. Table 3 Cross sectional analysis of abnormal price reaction Variables Constant BON PRECAR LMV BM

Sign Prediction

(+) (-) (-) (+) R2 33.1% F- Statistics 2.351 The Model is significant at 10% level of significance.

Coefficients 1.740(1.363) .245(1.679)* .505(1.972)* -2.244(-1.478) 0.09167(.529)

This Table provides the cross-sectional regression results explaining the market response to bonus issue announcement. The dependent variable used in this regression is the three-day Cumulative abnormal price movement from the day prior to the day after the announcement (day -1 to day 1) employing the market adjusted model. Independent variables are BON- The ratio of number of shares issued to the number of shares outstanding. PRECAR is the pre announcement price movement from days -20 to 2 days before the bonus issue announcement. LMV is the logarithm of firm size; BM is book-to-market ratio. The t statistics are reported in parentheses. ***Significantly different from zero at the 1% level. **Significantly different from zero at the 5% level. *Significantly different from zero at the 10% level.

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SECTION 4: CONCLUSION This paper examines the stock market reaction and Liquidity changes around the bonus issue announcement of the chemical companies in India. The period under study ranges from January 2000 to January 2006. Bonus share option announcements made by Indian Chemical companies are associated with significantly negative abnormal returns. The analysis shows that bonus issues have a signaling effect but the effect is inversely related to stock price changes. The findings are similar with Papaioannou et al. (2002) and Mohanty (1999) while it differs from the findings of Peterson (1971), Healy Palepu (1988), Lamoureax and Poon (1987), Ikenbery et al.(1996), Mc Nichols and Dravid (1990), Obaidullah and Rao (1994), Srinivasan (2002), Masse et al. (1997). We found that the liquidity changes around the bonus issue announcement are not significant and rejects the liquidity hypothesis and supports the cash substitution hypothesis. The findings are similar with Copeland (1979), lakanishok and Lev (1987), Conroy et al. (1990) while it differs from the findings of Grinbalatt, Masulis and Titman (1984). Denis Kadlec (194), Eckbo et al. (2000), Beneish and whaley (1996), and Lynch and Mendenhall (1997). The change in the abnormal returns due to bonus issue announcement is significantly influenced by size of bonus issue and the Pre cumulative abnormal return. However, the Pre cumulative abnormal returns are having an inverse effect and hence, there is no leakage of information prior to the bonus issue announcement in the Indian Chemical Industry. Size of the company and book to market ratio do not affect the abnormal returns. Thus, there seems to be under-reaction in the stock market around bonus issue announcement and the extent of reaction is mainly dependent on the size of the bonus issue. The findings are similar with Balachandran et. al. (2004) and Adouglu (2005). The findings suggest that firms need to consider the underreaction of the stock market after the bonus issue. The results obtained may help the financial policy decision makers to assess the effect of their dividend decisions on the companies’ profitability. This finding is also useful to investors while making their trading decisions. The study being limited to one single industry, empirical evidence comparing the overreaction or underreaction across industries, might give us more new insights about the announcement effect and Liquidity changes around bonus issues. A study considering a much larger sample size may also augment the findings of this study. References: A. Marsden, Shareholder wealth effects of rights issues: evidence from the New Zealand capital market. Pacific- Basin Finance Journal 8, 2000, 419–442. A. R. Cowan, N. Nayar, & A.K. Singh, Stock returns before and after calls of convertible bonds, Journal of Financial and Quantitative Analysis, 25, 1990, 549-554 B. Balasingham, R. Faff & S. Tanner, Further evidence on the announcement effect of bonus shares in an imputation tax setting, Global Finance Journal, 15, (2004) 147– 170 B. E. Eckbo, & R. W. Masulis, Adverse selection and the rights offer paradox. Journal of Financial Economics 32, 1992, 293–332. B. M. Barber, & J.D. Lyon, Detecting abnormal operating performance: The empirical power and specification of test statistics, Journal of Financial Economics, 41, 1996 359-399. Boehmer, E., J. Musumeci & A.B. Poulsen, Event study methodology under conditions of event-induced variance, Journal of Financial Economics 30(2), 1991, 253-272. C. Adaoglu, Market reaction to “unsweetened” and “sweetened” rights offerings in an emerging European stock market, journal of Multifinancila Management, 2005. C. G. Lamoureux, & P. Poon, The market reaction to stock splits. Journal of Finance, 42, 1987, 1347– 1370. C. J. Muscarella, M. S. Piwowar, Market microstructure and securities values: evidence from the Paris Bourse. Journal of Financial Markets 4, 2001, 209–229.

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