FAMA, FISHER, JENSEN AND ROLL In answer to the first question we shall show that stock splits are usually preceded by a period during which the rates of return (including dividends and capital appreciation) on the securities to be split are unusually high. The period of high returns begins, however, long before any information (or even rumor) concerning a possible split is likely to reach the market. Thus we suggest that the high returns far in advance of the split arise from the fact that during the pre-split period these companies have experienced dra matic increases in expected earnings and dividends. In the empirical work reported below, however we shall see that the highest average monthly rates of return on split shares occur in the few months immediately preceding the split. This might appear to suggest that the split elf provides some impetus for increased returns. We shall present evi- dence, however, which suggests that such is not the case The evidence sup- ports the following reasoning: Although there has probably been a dramatic increase in earnings in the recent past in the months immediately prior to he split (or its announcement) there may still be considerable uncertainty in the market concerning whether the earnings can be maintained at their new higher level. Investors will attempt to use any information available to reduce this uncertainty, and a proposed split may be one source of such In the past a large fraction of stock splits have been followed closely by dividend increases-and increases greater than those experienced at the time by other securities in the market. In fact it is not unusual for dividend change to be announced at the same time as the split. studies (ef. Lintner [10] and Michaelsen [14]) have demonstrated that dividends have been increased, large firms show great reluctance to reduce them, except under the most extreme conditions Directors have appeared to hedge against such dividend cuts by increasing dividends only when they are quite sure of their ability to maintain them in the future, i. e. only when they feel strongly that future earnings will be sufficient to maintain the dividends at their new higher rate Thus dividend changes may be assumed to convey important information to the market concerning managements 4 There is another question concerning stock splits which this study does not con ider. That is given that splitting is not costless, and since the only apparent result is to multiply the number of shares per shareholder without increasing the share holders claims to assets, why do firms split their shares? This question has been the subject of considerable discussion in the professional financial literature. (Cf Bellemore and Blucher [1].) Suffice it to say that the arguments offered in favor of splitting usually turn out to be two-sided under closer examination -e.g, a split, by reducing the price of a round lot, will reduce transactions costs for some rela tively small traders but increase costs for both large and very small traders (i. e for traders who will trade, exclusively, either round lots or odd lots both before and after the split). Thus the conclusions are never clear-cut. In this study we shall be concerned with identifying the factors which the market regards as important in a tock split and with determining how market prices adjust to these factors rather han with explaining why firms split their shares