Florida State University Libraries Electronic Theses, Treatises and Dissertations The Graduate School 2007 Reverse Stock Splits: Motivations, Effectiveness and Stock Price Reactions Barry Marchman Follow this and additional works at the FSU Digital Library. For more information, please contact [email protected] THE FLORIDA STATE UNIVERSITY COLLEGE OF BUSINESS REVERSE STOCK SPLITS: MOTIVATIONS, EFFECTIVENESS AND STOCK PRICE REACTIONS By BARRY MARCHMAN A Dissertation submitted to the Department of Finance in partial fulfillment of the requirements for the degree of Doctor of Philosophy Degree Awarded: Summer Semester 2007 The members of the Committee approve the dissertation of Barry Marchman defended June 5, 2005 Gary Benesh Professor Directing Dissertation Rick Morton Outside Committee Member Stephen Celec Committee Member Yingmei Cheng Committee Member Approved: Caryn L Beck-Dudley, Dean, College of Business The Office of Graduate Studies has verified and approved the above named committee members. ii For RC JAM and Evelyn iii ACKNOWLEDGEMENTS A work of this nature is never done in a vacuum. I am grateful for all of the help and encouragement from family, friends, and colleagues. My deepest debt of gratitude and most sincere appreciation goes to Gary Benesh. Thank you for seeing me through. I am grateful to my committee members, Rick Morton, Yingmei Cheng, and Steve Celec for helping me finish. I would also like to thank Don Nast and Bill Anthony for their constant encouragement and their belief in me. I thank Bill Christiansen, James Ang, and David Peterson for all that they taught me. Pam Peterson got me started on this study and I acknowledge her contribution. I thank Scheri Martin for keeping me on track. I am grateful to Caroline Jernigan and Daiho Uhm for SAS help and I am thankful to all my FSU officemates, classmates, and other colleagues for their support and friendship. I am grateful to my friends and colleagues at SBI, especially Amos Bradford and Charles Evans, for giving me the means to provide for my family during this process. I thank Kenneth Gray and Colin Benjamin for their constant encouragement. I am grateful to my family. I thank my parents, Mac and Tillie Marchman, for all of their love, support, and encouragement through this process. I owe a special debt of gratitude to Jack and Dianne Steen for making this all possible. I am especially indebted to my biggest cheerleader and best friend without whom I could not have finished, Evelyn. I am ultimately thankful to God for all of these relationships and for His blessings. iv TABLE OF CONTENTS LIST OF TABLES.........................................................................................................viii LIST OF FIGURES......................................................................................................... x ABSTRACT ................................................................................................................... xi CHAPTER 1: INTRODUCTION.....................................................................................1 1.1 Introduction and Motivation ...................................................................................1 1.2 What Is a Reverse Stock Split?.............................................................................3 1.2.2 A Brief Overview of the Evidence on Forward and Reverse Stock Splits ........4 1.2.2.1 Anecdotal ..................................................................................................4 1.2.2.2 Forward Split Empirical Findings ...............................................................6 1.2.2.3 Reverse Split Empirical Findings...............................................................7 1.3 Why Reverse Split?...............................................................................................7 1.3.1 Listing Requirements.......................................................................................8 1.3.2 Transaction Costs .........................................................................................10 1.3.3 Marginability ..................................................................................................10 1.3.4 Signaling........................................................................................................11 1.4 Hypotheses .........................................................................................................12 1.4.1 Stock Price Reactions ...................................................................................12 1.4.2 Financial Health.............................................................................................14 1.4.3 Listing Requirements.....................................................................................15 1.5 Outline of This Dissertation .................................................................................16 CHAPTER 2: LITERATURE REVIEW.........................................................................17 2.1 Why Does a Firm Split Its Stock?........................................................................17 2.1.1 Asymmetric Information (Signaling)...............................................................19 2.1.2 Signaling Combined with Transaction Costs .................................................21 2.1.3 Trading Range...............................................................................................21 2.1.4 Institutional Reasons to Reverse Split...........................................................24 2.1.5 Margin Regulations .......................................................................................25 2.1.6 Reorganization ..............................................................................................26 2.1.7 Liquidity .........................................................................................................27 2.1.8 Risk ...............................................................................................................27 2.1.9 Investor Behavior in Relation to Stock Splits.................................................28 2.1.9.1 Framing ...................................................................................................29 2.1.9.2 Price Preference......................................................................................30 2.1.9.3 Herding....................................................................................................31 2.1.10 Optimal Tick Size (Market Microstructure)...................................................31 2.2 Conclusion ..........................................................................................................32 2.2.1 What We Know..............................................................................................32 2.2.2 What We Do Not Know .................................................................................33 2.2.2.1 Managers’ Self-interest............................................................................34 2.2.2.2 Shareholders’ Best Interest .....................................................................35 v CHAPTER 3: METHODOLOGY AND RESULTS........................................................36 3.1 Stock Price Reactions .........................................................................................36 3.1.2 Raw Returns Around the Announcement Day...............................................38 3.1.3 Market Adjusted Returns Around the Announcement Day ............................40 3.1.4 Market Model Adjusted Returns Around the Announcement Day .................41 3.1.5 Announcement Day Conclusions ..................................................................42 3.1.6 Ex-date Raw Returns ....................................................................................42 3.1.7 Ex-date Market Adjusted Returns..................................................................44 3.1.8 Ex-date Market Model Adjusted Returns.......................................................44 3.1.9 The relation between ex-date returns and announcement date returns ........45 3.1.10 Analysis of Subsamples Based on Firm Categories....................................46 3.1.10.1 Industry..................................................................................................46 3.1.10.2 Delisting threat and Motivations for Reverse Splits ...............................49 3.1.10.3 Price ......................................................................................................52 3.1.10.4 Size of the Firm ....................................................................................53 3.1.10.5 Consolidation.........................................................................................54 3.1.11 Long-run Returns Following Reverse Stock Split ........................................55 3.1.12 Long Run Buy and Hold Returns.................................................................55 3.1.13 Long-run Abnormal Returns ........................................................................59 3.1.14 Matched Firm Analysis ................................................................................62 3.1.15 Analysis of Subsamples Based on Firm Categories....................................64 3.1.15.1 Industry..................................................................................................64 3.1.15.2 Delisting Threat and Motivations for Reverse Stock Splits ....................65 3.1.15.3 Price Considerations .............................................................................66