Why Do Companies Reverse Split Stock?

Investors are responsible for monitoring their stock purchases. A lot of things can happen to a company and its stock. Stocks can split or reverse split, companies acquire other companies or merge, change their name, the firm can be taken private or declare bankruptcy and vanish from the stock market. Some events are positive events for investors; others are not. Reverse splits are typically the result of negative forces. Some companies survive and thrive following reverse splits, many do not.

One share of stock represents one unit of ownership in a company. The market determines stock prices. If the company does well and prospers, the stock price increases. If the company is having problems, the stock price declines. Companies with high stock valuations sometimes carry out a stock split. A 2:1 stock split means an investor with 100 shares will own 200 shares after the split. When a company is doing poorly and the stock price slides downward, companies may announce a reverse split. A 1:10 split means for every 10 shares of stock owned, the investor will now possess one share of stock. An investor owning 100 shares of a stock would then own 10 shares.

Companies facing delisting from a stock exchange often reverse split stock. Companies must meet requirements to be listed on an exchange and maintain certain standards to remain on major stock exchanges, including the NYSE Euronext and the NASDAQ. One requirement is a minimum bid price for stock. The NYSE and the NASDAQ have the same minimum bid requirements. If a company’s stock price falls below $1 for 30 consecutive trading days, the company’s exchange listing will be evaluated; the company is in danger of being delisted from the exchange. A reverse split is an acceptable means of complying with the rule that the stock bid price stay above $1.

A company may reverse split stock because it wants the stock price to be higher. Many investors will not consider an investment in a company with stock trading for a low price, especially stocks trading under $1. Many institutional investors, such as some mutual funds and pension funds, are not permitted to invest in stocks selling for less than a certain dollar figure, often defined in the rules as under $5. A company may decide a reverse stock split will halt a precipitous decline in the stock price. A higher stock price may be perceived as a company’s attempt to turn the company’s fortunes around.

Often reverse splits do not work because the company is headed into bankruptcy and no amount of stock maneuvering is going to change that eventual outcome. A reverse split may be seen as an effort to reassure investors, but if the company is not successful in reversing the company’s decline it will not help. The company will fail and investors lose money. One of the most well-known stock splits was announced in June, 2009 by AIG, a major financial institution impacted by the 2008 financial crisis. The stock split 1:20. The stock declined after the initial announcement and stock split, but has since recovered. As of March 21, 2011, AIG’s stock price was up 140 percent since the split.