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S. Vaidya Nathan

COMPANIES should continue to have freedom to use capital restructuring devices such as stock splits. A company and its shareholders are best placed to decide if a stock-split would be beneficial or not. There would appear to be no case for any regulatory intervention in this area. But the Secondary Markets Committee of the Securities and Exchange Board of India (SEBI) thinks otherwise.

The Committee has proposed that a company should be allowed to split its stock only if the market price exceeds Rs 500 (for shares with a face value of Rs 10). This would unnecessarily deprive companies whose shares trade at prices lower than this threshold a chance to create abetter market for their shares by seeking recourse to stock split.

Such a restriction could also impose a burden on shareholders by way of opportunity loss; it would also lead to a needless discrimination between shareholders of different companies just because their absolute price levels are different.

A stock split reduces the face value of a share and increases the number of outstanding shares without altering a company's equity. For instance, a stock split in the ratio of 10:1 leads to an investor having ten shares of face value Rs 1 each instead of one share with a face value of Rs 10. It is a wealth-neutral exercise.

However, a re-rating can happen because of improved liquidity due to the availability of more number of shares for trading, and the lower price that makes the stock more affordable. These two factors stoke a higher degree of investor interest, and could also lead to value enhancement over a period. This re-rating linked to stock split tends be pronounced and immediate in bullish markets; it is tepid and phased out when the market is either flat or on a downtrend.

For instance, Elgi Equipments split its stock in the ratio of 10:1 when it was trading at less than Rs 150 and the market conditions were sluggish. After the split, the stock languished in the Rs 15-18 range before the recent bullish phase bestowed considerable investor interest in this mid-cap stock.

The availability of a larger number of shares played no mean a role in attracting institutional investor interest in the stock that now figures in quite a few fund portfolios, and trades at about Rs 70.

A similar trend was seen in stocks such as Madras Cements, Glenmark Pharmaceuticals and L. G. Balakrishnan Brothers. More than large-cap stocks (a sizeable number of which trade at high absolute price levels), it is the mid- and small-cap stocks that need such avenues as a stock split to improve liquidity. This category, unlike large-cap stocks, faces the problem of low liquidity, which leads to exaggerated price movements even when small quantities are bought or sold.

The reasons cited by the SEBI Committee are tenuous. Its contention is that stock splits make comparison between companies difficult. Yes, absolute prices tend to differ sharply if some companies resort to stock split. But even without stock split, there is wide divergence in stock prices of different companies in any industry.

A stock split also does not impact key evaluation parameters such as price-earnings multiple, return on shareholder funds and capital employed.

As there is very little basis to commend the proposal, SEBI should put it cold storage for good. No company deserves to be deprived of resorting to a stock split because its stock price is less than Rs 500.

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