Answer to Question #6758 in Economics of Enterprise for LaMarcus Streeter
3. Which of the following statements is CORRECT?
a. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used.
b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today.
c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits.
d. When a company declares a stock split, the price of the stock typically declines—by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the equity.
e. If a firm’s stock price is quite high relative to most stocks
Statement E is CORRECT. If a firm's stock price is quite high relative to most stocks then it can declare a stock split. Stock split occurs when a company divides a stock's price by a ratio relative to the number of additional shares being issued - say 2-for-1. Regardless of the ratio, the stock price will decline and the quantity of shares outstanding will increase. A stock split is typically a consequence of outstanding performance and causes more shares available to trade.