Bridge over ocean
1 January 1979 Financial Analysts Journal Volume 35, Issue 1

The Price Impact of Reverse Splits

  1. Robert C. Radcliffe
  2. William B. Gillespie

If, in principle, reverse splitting of common shares has no impact on the value of a firm, why do a large number of such splits occur every year? There are three possible reasons. First, managements may use reverse splitting to reduce their registrars’ fees and shareholder mailing costs. Since it is unlikely, however, that the minimal future benefits to be gained would in most cases offset the immediate costs involved, this rationale deserves little consideration.

Second, managements may use reverse splits to improve share marketability—the ease and speed with which a buyer can find a seller and vice versa—by maneuvering share prices into some range perceived as preferable to investors. To test whether reverse splits can improve share marketability, the authors segregated their data into three groups—(1) stocks with post-split prices in the split month of less than five dollars, (2) stocks with post-split prices between five and 15 dollars and (3) stocks with post-split prices over $15. They detected no significant differences between the groups in either split month or post-split month price movements.

Third, managements may use reverse splits as an informal device for conveying to shareholders information about a firm’s future earnings’ prospects or dividend policies. According to the authors’ findings, price behavior of dividend and non-dividend paying companies did not differ significantly. On the other hand, both types of companies saw their share prices deteriorate significantly during the month of the split: If reverse splits convey any information to shareholders, it is evidently negative.

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