Reverse Splits and Shareholder Wealth: The Impact of Commissions

Abstract

In a recent issue of this journal, Woolridge and Chambers [7] examined the impact of reverse stock splits on shareholder wealth. Their major conclusion was that stock prices of those firms engaging in reverse splits decline by a statistically significant amount on and shortly after the date the split is first publicly announced (the proposal date) and on and shortly after the effective date of the split. These results suggest the possibility that significant excess returns are available to investors trading on the published news of reverse stock splits. If these excess returns are available after considering the necessary transactions costs, then the Woolridge and Chambers study could constitute an important piece of evidence contradicting the semi-strong form of market efficiency. In addition, these findings also suggest to financial managers that engaging in reverse splits may not be consistent with the maximization of shareholder wealth. In Section II we look at the impact of transactions costs on returns based upon the average stock prices from the Woolridge and Chambers' study. In Section III, we perform a similar analysis based on individual stock data and transactions costs that would have been i curred at the time of each event. Section IV considers the effect of short sales; Section V discusses the results and offers implications for financial managers.