A Further Understanding of Stock Distributions: The Case of Reverse Stock Splits

Abstract

In this study we analyze reverse stock splits and demonstrate that the total risk of returns to reverse splitting securities declines after the split, yet systematic risk remains essentially unchanged. In general, securities have negative abnormal stock returns at reverse split announcements, though smaller companies have stronger negative reactions. Companies forced to reverse split have positive wealth effects.

The effect of reverse stock split on the Warsaw Stock Exchange

“…[Leland, Pyle 1977;Brennan, Hughes 1991;Conroy, Harris 1999;Ikenberry, Rankine, Stice 1996]). Other studies also revealed an aspect of reduced transaction costs on the American market after reverse stock split [Peterson, Peterson 1992;West, Brouilette 1970].…”

“…Moreover, authors of studies on reverse stock splits indicate a few other determinants of making decisions about reverse splits (see: [Peterson, Peterson 1992;Bacon, Salandro, Shin 1993;Marchman 2007]). One of more crucial determinants is marketing effect -improvement of issuer's image by getting rid of the opinion of "junk company."…”

Earnings Management to Avoid Delisting from a Stock Market

“…Nevertheless, prior literature documents significant costs associated with making RSS. Even though RSS typically succeed in increasing stock liquidity (Han 1995) they reflect management's pessimism about a firm's ability to reach attractive stock price levels and their announcement is associated with a negative stock price reaction that is especially large for small firms (Peterson and Peterson 1992). This implies that the decision on whether or not to make an RSS also reflects the trade-off between the costs and benefits.…”

“…In fact, NASDAQ explicitly states that it considers RSS as an acceptable method for firms violating the minimum bid price requirement to regain compliance. 5 Even though an RSS seems to be an easy way to increase a firm's stock price past research shows that announcing an RSS reveals managerial pessimism about their company's future and so firms tend to be reluctant to perform it (Peterson and Peterson 1992). Macey et al (2008) quote Barry Siegel, chairman and chief executive of Driversshield.com, who suggested that "a reverse split is an act of desperation.…”

Survival: A Motivation for Reverse Stock Splits

“…Another motivation for reverse splits is to reduce the number of shareholders to eliminate disclosure requirements [5]. Reverse splits may squeeze minority shareholders out, particularly in states where shareholders are not allowed to hold fractional shares, and this will decrease the cost of servicing shareholders.…”