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Journal of Economics and Finance

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01-04-2015

Multiple reverse stock splits (investors beware!)

Authors: Claire E. Crutchley, Steven Swidler

Published in: Journal of Economics and Finance | Issue 2/2015

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Abstract

This study compares firms that implement multiple reverse stock splits to firms with only one reverse stock split. Reverse stock splits are usually implemented by firms trying to increase their stock price to remain listed on stock exchanges or widen stock ownership especially by institutional investors. Firms that declare multiple reverse splits tend to have lower returns following the reverse split and even less liquidity than one reverse split firms. Sixty five percent of the firms with multiple reverse splits end up being liquidated or delisted. If one reverse split is viewed as desperation, then multiple reverse stock splits are a sign of extreme distress.

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While reverse splits lead to negative performance, on average, there may be ex-ante reasons for managers to believe a reverse split will increase firm value. For example, if exchange listing maintains visibility, announcement of a reverse split may increase value.

Martell and Webb (2008) suggest three additional reasons: 1) increasing institutional ownership, 2) reducing the number of shareholders before taking the firm private and 3) reducing the number of small shareholders to save servicing expenses. The first reason gets back to liquidity, while reasons 2 and 3 seem to be of secondary importance, especially if there has been more than one reverse split.

Of the five companies that initiated a reverse split five times, the most extreme case is Members Service Corp who reverse split the stock five times within four years from 1990 to 1994. Members Service Corp’s last two splits were 50 to 1 and 40 to 1. Shortly after the fifth reverse split the company was delisted, and within a few years, the company was investigated by the SEC for fraud.

The first line of the table 1980–1989 shows there were 47 reverse splits for companies who also had at least one reverse split between 1990 and 2010; all of these companies are classified in the multiple reverse split category.

There are two outliers which skew the mean market value of those with a third reverse split; one has a market value above $2 Billion and one has a market value of approximately $700 million. The next largest company has a market value below $100 million.

Chung KH, Yang S (2010) Reverse Stock Split and Institutional Investor Behavior, Working Paper

Desai H, Jain PC (1997) Long-run common stock returns following stock splits and reverse splits. J Bus 70:409–433CrossRef

Han KC (1995) The effects of reverse splits on the liquidity of the stock. J Financ Quant Anal 30:159–169CrossRef

Hwang CY (1995) Microstructure and reverse stock splits. Rev Quant Finance Account 5:169–177CrossRef

Kim S, Klein A, Rosenfeld J (2008) Return performance surrounding reverse stock splits: can investors profit? Financ Manag 37:173–192CrossRef

Lamoureux CG, Poon P (1987) The market reaction to stock splits. J Finance 42:1347–1370CrossRef

Martell TF, Webb GP (2008) The performance of stocks that are reverse split. Rev Quant Finance Account 30:253–279CrossRef

Peterson DR, Peterson P (1992) A further understanding of stock distributions: the case of reverse stock splits. J Financ Res 15:189–205CrossRef

Radcliffe RC, Gillespie WB (1979) The Price Impact of Reverse Splits. Financial Analysts Journal, 63–67

Woolridge JR, Chambers DR (1983) Reverse Splits and Shareholder Wealth. Financ Manag, 5–15

Title: Multiple reverse stock splits (investors beware!)
Authors: Claire E. Crutchley
Steven Swidler
Publication date: 01-04-2015
Publisher: Springer US
Published in: Journal of Economics and Finance / Issue 2/2015
Print ISSN: 1055-0925
Electronic ISSN: 1938-9744
DOI: https://doi.org/10.1007/s12197-013-9259-x

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