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The performance of stocks that are reverse split

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Abstract

An unusually high number of Nasdaq National Market stocks were reverse split following the decline in Nasdaq prices in the year 2000. We test whether these splits were driven by the overall market decline. We find that the performance of stocks with reverse splits in poor overall stock market conditions is better (less negative) than that in good market conditions, and that the differences in performance appear three to five months after the split. This suggests that the longer-term outcomes of reverse stock splits are associated with the market environment at the time of the split. In view of this, changes that Nasdaq made to relax some of its listing standards are well justified.

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Notes

  1. A reverse stock split is one in which the firm raises its stock price and reduces the number of shares outstanding. For example, in a 1:10 reverse split, the firm ends up with 1 new share for 10 old shares, and the price of each share is higher by a factor of 10. Just as in the case of a forward stock split, the market value of the firm’s equity should be unchanged by the reverse split.

  2. These figures are based on data from the Daily Stock File from the Center for Research in Securities Prices, 2003.

  3. So and Tse (2000) develop the “target-price” habit hypothesis: firms split their stocks to conform to a market norm price. They emphasize that the forward split is voluntary on the part of the firm’s managers, and therefore, the target-price habit cannot apply to reverse splits.

  4. We apply two additional screens. (1) If a particular stock has two reverse splits in one year, we retain the first but skip the second. (2) We exclude smaller reverse splits in which the resulting number of shares is reduced by less than 25%. This corresponds to a ratio of 1:1.33, or 1 new to 1.33 original shares. Together these screens result in the elimination of just 19 reverse splits.

  5. We test the robustness of the results by using an alternative index, the CRSP equally-weighted index for Nasdaq stocks. The results are qualitatively the same as those based on the value-weighted index.

  6. These are trading days. Thirty trading days corresponds to about one and one-half months in calendar time, and 50 trading days corresponds to about two and one-half months.

  7. The monthly portfolio returns are value-weighted, based on market equity capitalization. Consistent with other researchers, we include only months with four or more stocks. Also, we trim 1% of the extreme values.

  8. The market and factor data are from the data library of Kenneth French, at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

  9. See, for example, Nasdaq Press Release, “Nasdaq to Reinstate Requirements for Minimum Bid Price and Market Value of Public Float,” December 12, 2001.

  10. We use the CRSP variable “bidlo” as a measure of the closing bid price.

  11. For example, consider a hypothetical stock whose reverse split is on event day 0. Suppose that this stock’s last sequence of 10 closing bid prices over $1.00/share was on trading days −100 through −91 relative to the effective date of the split, and that all of its closing bid prices were under $1.00/share after that. The initial test period of 30 days covers trading days −90 through −61. Assuming that Nasdaq issues the deficiency notice immediately after the stock has 30 closing prices under $1.00 per share, the firm then goes on notice and has 90 calendar days to regain compliance. This period translates into about 64 trading days, and runs in event time through day +2, two days after the split.

  12. From 1991 to 1997, the minimum bid price for initial listing on the SmallCap market was $3.00/share.

  13. The results for the “on recent notice” and “not on notice” categories: the post-split returns, adjusted for the market, for both SmallCap and National Market stocks were significantly negative for both categories.

  14. The mean post-split risk-adjusted return of these stocks was +32.93%, and their median was +37.96%, and both are significantly different than zero.

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Acknowledgments

We thank Gayle DeLong, Armen Hovakimian, Robert Schwartz, Daniel Weaver and the editors of RQFA for constructive comments on an earlier version of this paper.

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Authors and Affiliations

  1. Department of Economics and Finance, Baruch College/The City University of New York, Box B10-225, 1 Bernard Baruch Way, New York, NY, 10010, USA

    Terrence F. Martell & Gwendolyn P. Webb

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  1. Terrence F. Martell
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  2. Gwendolyn P. Webb
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Correspondence to Terrence F. Martell.

Appendices

Appendix I: Selected changes in Nasdaq’s continued listing requirements of the minimum bid price

Since Nasdaq first instituted its minimum bid price requirements in 1991, the minimum bid price for continued listing has remained $1.00/share for both Nasdaq’s National Market (National Market) and its SmallCap (SmallCap) Market stocks (Nasdaq 2003). (As of 1997, the minimum bid price for initial listing is $5.00/share for Nasdaq National Market stocks, and $4.00/share for SmallCap stocks.)

On September 27, 2001, Nasdaq announced an across-the board emergency moratorium on the minimum bid and public float requirements for continued listing on Nasdaq. This moratorium was to remain in effect until January 2, 2002 (Nasdaq Press Release 2001a).

On December 12, 2001, Nasdaq announced several modifications to be implemented on a pilot basis and to remain in effect until December 31, 2003 (Nasdaq Press Release 2001b):

  • The grace period of 90 calendar days was reinstated for National Market stocks. In its announcement, Nasdaq added that it “believes that the current 90-day grace period for Nasdaq National Market companies to regain compliance with the market value of public float and minimum bid price requirements are appropriate and commensurate with the stature of that market.” This underscores the differences in quality between the stocks traded on the National and SmallCap Markets.

  • The grace period for SmallCap stocks was extended to 180 calendar days.

  • The grace period for a SmallCap stock could be extended for an additional 180 calendar days if the firm meets certain minimum requirements of net income, stockholders’ equity, or market capitalization.

  • If a National Market issuer is unable to meet the minimum bid price requirement in its 90-day grace period, then it may “phase down” to the SmallCap market rather than be delisted from Nasdaq altogether. The firm then qualifies for the longer grace period of 180 days on the SmallCap market. Although the National Market grace period is unchanged from the original period of 90 calendar days, the flexibility to “phase down” to the SmallCap market means that the consequence of a compliance failure is mitigated. Instead of being delisting from Nasdaq altogether, the stock may now continue trading on the SmallCap market.

  • If a National Market issuer that phased down to the SmallCap meets the $1.00/share minimum bid price requirement for 30 consecutive trading days, then it will be eligible to “phase up” to the National Market market.

On January 30, 2003, Nasdaq extended the pilot program for another year, so that it would expire on December 31, 2004, and made additional changes to the grace periods (Nasdaq Press Release 2003):

  • The grace period for all National Market issuers was extended from 90 to 180 calendar days.

  • The grace period for an National Market issuer may be extended for an additional 180 calendar days if the firm is in compliance with the core National Market initial listing criteria.

  • For SmallCap stocks, the initial 180 calendar day grace period is unchanged, but the additional grace period is extended from 180 days to 540 days for issuers that are in compliance with the core SmallCap initial listing criteria. The core initial listing standards for SmallCap firms are that the firm must either have net income of $750,000, stockholders’ equity of $5 million, or market capitalization of $50 million.

Appendix II: Our samples of reverse splits

Our base sample of reverse stock splits is drawn from the Center for Research in Securities Prices (CRSP) daily stock file with data through 2003. It includes reverse splits that meet these criteria:

  1. 1.

    The stock is common stock, and has CRSP share code (shrcd) 10 or 11.

  2. 2.

    The stock has no more than 50% missing returns in the 30 trading days before the effective date of the split, and no more than 50% missing returns in the 30 trading days beginning on the effective date.

  3. 3.

    If a particular stock has two reverse splits in one year, we retain the first but skip the second. This screen results in the elimination of just eight reverse splits.

  4. 4.

    We exclude smaller reverse splits in which the resulting number of shares is reduced by less than 25%. This corresponds to a ratio of 1:1.33, or 1 new to 1.33 original shares. This screen results in the elimination of just 11 reverse splits.

The base sample includes 1,435 reverse splits of Nasdaq stocks, and 233 splits of NYSE and Amex stocks.

Our sub-sample of Nasdaq reverse-split stocks includes all of the splits that meet these additional criteria:

  1. 1.

    The reverse split was done by a Nasdaq stock denoted by CRSP as either being listed on the Nasdaq National Market or its SmallCap Market. Because these market data begin in 1982, our sub-sample begins in 1982.

  2. 2.

    The sub-sample period ends at June 30, 2003, to allow for at least 6 months of post-split returns data.

  3. 3.

    The stock’s average closing price in the 30-trading days before the effective date of the split is $10.00/share or lower.

  4. 4.

    The reverse split is in the ratio of 1 new share for 2 or more old shares, i.e., splits of 1:2, or higher.

  5. 5.

    The intended or target price is $20.00/share or lower. The target price is equal to the average pre-split stock price adjusted for the split factor. (See also Table 4.)

  6. 6.

    The split was not undertaken within six months of any other event that also has an affect on the stock price, such as a forward stock split, a merger or acquisition, or a securities issuance.

The sub-sample includes 1,199 Nasdaq reverse stock splits.

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Martell, T.F., Webb, G.P. The performance of stocks that are reverse split. Rev Quant Finan Acc 30, 253–279 (2008). https://doi.org/10.1007/s11156-007-0052-9

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