Reverse Stock Splits Research Articles

Microstructure and reverse stock splits

In this paper we show that, similar to NYSE/AMEX stocks, NASDAQ stocks exhibit significant ex date returns for reverse stock splits. Although the 10-day cumulative return after the ex date is close to −10%, this does not violate market efficiency, because the average bid-ask spread for the reverse split stock is at least double this return. We also document that these large negative returns are mostly due to a drop in the ask price while bid prices barely change at all. Furthermore, the ex date returns are negatively related to trading volume. These results suggest that there is abnormal selling and a significant buildup of market makers' inventories near the ex date. To reduce the inventory buildup, market makers lower ask prices to induce buying by investors, resulting in the observed negative returns. Lowering bid prices, an alternative strategy for reducing inventories, is not attractive to market makers due to competitive factors and the reduction of commissions associated with a smaller number of transactions. Notably, selling investors have no incentives to sell their stocks early to avoid the observed negative ex date return, since this return is largely an ask price phenomenon and does not represent realized returns to sellers.

The Effects of Reverse Splits on the Liquidity of the Stock

This study investigates the liquidity effects of reverse stock splits using bid-ask spread, trading volume, and the number of nontrading days as proxies for the liquidity of the stock. Results indicate a decrease in bid-ask spread and an increase in trading volume after reverse splits. More importantly, the number of nontrading days significantly declines following reverse splits. For the control group, however, no such changes are observed. These results suggest that reverse splits enhance the liquidity of the stock.

Management's View of Reverse Stock Splits

Management's View of Reverse Stock Splits

Reverse Splits and Shareholder Wealth: The Impact of Commissions

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.