As you know a reverse stock split for a company reduce its number of shares traded on the exchange. As a result it impacts the shareholder more than any one else related to the company. Unlike the normal stock split, reverse stock split is seen as a bad sign for the shareholder.

As you know a reverse stock split for a company reduce its number of shares traded on the exchange. As a result it impacts the shareholder more than any one else related to the company. Unlike the normal stock split, reverse stock split is seen as a bad sign for the shareholder.

Reverse Stock Split Targets Reduction of Shareholders

A reverse stock split not only reduces the number of shares but also reduces the number of shareholders. For every shareholder, there is a minimum limit on the no. of shares he/she should hold at any time. When a reverse stock split happens the number of shares on the market reduces and the share price increases. In the same scale the no. of shares held by all investors reduces.

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« Reverse Stock Split – What is It?
Reverse Stock Split Examples – Aig, Citigroup, Gm Etc »

But those shareholders who are having less number of shares than the minimum limit are forced to leave the shares by taking the cash equivalent of the total share value they were holding during the reverse split.

This in turn helps the company reduce their shareholder numbers and avoid having to pay dividends to each and every one. Their annual reports and other reports cost will reduce with the number of shareholders. Overall though the market capitalization of the stock remains the same, it only benefits the company management and affects the small shareholders.

Reverse Stock Split Signals about Company

A reverse stock split is not a common term in stock market news. It is announced once in a while by few companies that are deeply in trouble. That is the reason why they suddenly announce reverse splits in very high ratios (1:20, 1:100) unlike straight splits which are typically 1:2, 1:4 etc.

The company may be in deep trouble financially that the stock price instead of being stable, kept on falling down like in a bottomless pit. Citigroup’s shares were finest example of this. And so were AIG’s shares after a reverse split.

Unless some government intervention or some fool wants to buy the losing company, the shares are not backed-up and hence even after the split they will go down. Citigroup had US government’s unrelenting support and hence it is expected to do well even after the reverse split in 2009.

Reverse Stock Split Helps Avoid Delisting

A reverse stock split also helps the company from getting delisted from the exchanges. If the share price falls too low, then it might just be $0.01 or Rs. 0.01. Then how can the shares be traded on the exchanges? The exchange tells the company to buy all the shares and get delisted. By that time every shareholder would have been broke anyway.

Reverse stock split helps increase the price and avoid getting delisted like this. It also helps the stock from falling into penny stocks group whose shares typically trade at prices like $0.05, $0.1 etc. or Rs. 0.5, Rs. 1.1 etc. When a 1-for-20 reverse split is announced a $0.1 share raises to $2.

Reverse Stock Split also Considers Institutional Investors

Institutional investors have a minimum cut-off rule on the price of share before taking a stake in it. For example, $5 or Rs. 20. If the stock price falls below that the institutional investors do not give support to the stock and may even start selling it. To avoid this dangerous fallout, the companies announce a reverse split.

But most often the reverse splits are announced by the time the game is over. And it may not help the shareholder much.

Resources:

http://www.learningmarkets.com/index.php/200903251773/Stocks/Investing-Basics/understanding-reverse-stock-splits.html

http://www.bizzia.com/articles/the-effect-of-aigs-reverse-stock-split/

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