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... 81 4.2.1 Stock Price Reactions – Announcement Date .81 4.2.2 Stock Price Reactions – Ex-date 82 4.2.3 Stock Price Reactions – Firm Characteristics 82 4.2.4 Stock Price Reactions. .. the health of the stock as related to reverse stock splits 1.4.1 Stock Price Reactions The first hypothesis tested relates to the stock price reactions associated with reverse stock splits Researchers... listing requirements in 2001 and its effects on reverse stock splits and delistings 3.1 Stock Price Reactions This section deals with the stock price reaction to a reverse stock split Event study
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 UMI Number: 3282643 UMI Microform 3282643 Copyright 2007 by ProQuest Information and Learning Company. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest Information and Learning Company 300 North Zeeb Road P.O. Box 1346 Ann Arbor, MI 48106-1346 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 3.1.15.4 Size of the Firm .....................................................................................66 3.1.15.5 Consolidation.........................................................................................67 3.1.15.6 Long-run Analysis Concluding Remarks................................................68 3.2 Market Movements and Reverse Stock Splits .....................................................68 3.2.1 Hypothesis.....................................................................................................68 3.2.2 Testing ..........................................................................................................69 3.2.3 Results ..........................................................................................................70 3.3 Financial Distress and Future Performance ........................................................70 3.3.1 Hypothesis.....................................................................................................70 3.3.2 Testing ..........................................................................................................71 3.3.3 Results ..........................................................................................................72 3.3.4 Concluding remarks ......................................................................................74 3.4: NASDAQ Regulatory Changes..........................................................................74 3.4.1 NASDAQ Listing Rules – Before The Pilot Program .....................................75 3.4.2 The Pilot Program .........................................................................................76 3.4.3 Hypotheses ...................................................................................................77 3.4.4 Reverse splits and the Moratorium................................................................78 3.4.5 Delistings and the Moratorium.......................................................................79 vi CHAPTER 4: CONCLUSIONS .....................................................................................81 4.1 Overview .............................................................................................................81 4.2 Results and Suggestions for Further Research...................................................81 4.2.1 Stock Price Reactions – Announcement Date...............................................81 4.2.2 Stock Price Reactions – Ex-date ...................................................................82 4.2.3 Stock Price Reactions – Firm Characteristics................................................82 4.2.4 Stock Price Reactions – Long Run................................................................83 4.2.5 Market Movements........................................................................................83 4.2.6 Projecting Post Split Performance.................................................................84 4.2.7 NASDAQ Rule Change .................................................................................84 4.3 Contribution .........................................................................................................85 APPENDICES ..............................................................................................................87 BIBLIOGRAPHY ........................................................................................................169 BIOGRAPHICAL SKETCH.........................................................................................176 vii LIST OF TABLES Table 1 Forward and Reverse Stock Splits and Split Ratios 1962-2002 ................87 Table 2 Average Stock Price per Year and Yearly Stock Splits 1962-2002 ...........88 Table 3 Changes in Margin Requirements .............................................................90 Table 4 Winners Versus Losers After Reverse Stock Split.....................................90 Table 5 Summary of Stock Split Literature and Key Findings ................................91 Table 6 The Daily Raw Returns of Reverse Stock Splits Around the Announcement Date ................................................................................96 Table 7 The Daily Market Adjusted Returns of Reverse Stock Splits Around the Announcement Date ..........................................................................96 Table 8 The Daily Market Model Adjusted Returns of Reverse Stock Splits Around the Announcement Date ..............................................................98 Table 9 The Daily Raw Returns of Reverse Stock Splits Around the Ex-date......100 Table 10 The Daily Abnormal Returns of Reverse Stock Splits Around the Exdate - Market Adjusted..........................................................................102 Table 11 The Daily Market Model Adjusted Returns of Reverse Stock Splits Around the Ex-date ...............................................................................106 Table 12 Ex-date Returns vs. Announcement Returns ........................................110 Table 13 Number of Reverse Stock Splits by Industry 1962-2003 .......................111 Table 14 Ex-date Returns by Industry ..................................................................112 Table 15 Returns Based on Reason Given .........................................................114 Table 16 The Returns of Reverse Stock Splits by Price.......................................115 Table 17 The Returns of Reverse stock splits and the Size of the Firm ...............116 Table 18 The Returns of Reverse stock splits and Consolidation ........................117 Table 19 Reverse Stock Split Delistings Within 250 Days of Ex-date (19622003).....................................................................................................118 Table 20 Average Buy and Hold Returns of Reverse stock splits from 1962 to 2003......................................................................................................119 Table 21 Average Market Adjusted Buy and Hold Abnormal Returns of Reverse stock splits from 1962 to 2003 ................................................121 Table 22 Matched Firm Statistics .........................................................................123 Table 23 Average Abnormal Returns of Reverse stock splits from 1962 to 2003 Based on Matched Firm...............................................................124 Table 24 Long Term Returns By Industry.............................................................125 Table 25 Long Term Returns by Reason Given and Low-Priced Versus High Priced....................................................................................................130 Table 26 Long Term Returns By Size, Consolidation and Post Split Price..........131 Table 27 Monthly Stock Splits Related to Market Movements .............................132 Table 28 Long Run Returns Regressed on Lagged Market Returns....................133 Table 29 Regression Analysis of Financial Distress Variables – Definitions ........134 Table 30 Correlation Matrix: The Returns of Reverse Stock Splits and Financial Distress Variables..................................................................135 Table 31 Regression Analysis of Financial Distress Variables – Single Independent Variable............................................................................137 viii Table 32 Multivariate Regression Reduced Model ...............................................138 Table 33 Nasdaq Requirements September 2001 ...............................................139 Table 34 Low-priced Nasdaq Stocks and Reverse Stock Splits 1998 - 2005.......140 Table 35 Delistings Around the NASDAQ 2001 Moratorium ................................142 ix LIST OF FIGURES Figure 1 Reverse Stock Splits 1962-2002 ............................................................144 Figure 2 Split Ratios of Stock Splits .....................................................................145 Figure 3 Distribution of 250-Day Buy and Hold Returns.......................................146 Figure 4 Buy and Hold Returns of Reverse Stock Splits .....................................147 Figure 5 Market Adjusted Returns of Reverse Stock Splits..................................148 Figure 6 Matched Firm Abnormal Returns ...........................................................149 x ABSTRACT Stock price reactions to reverse stock splits are examined in relation to various firm characteristics and market movements. It is found that the market reacts stronger on the ex-date than on the announcement date. The market reaction varies by industry and by reason given for the reverse stock split. Firms that split for regulatory reasons perform worse than firms that split for other reasons. In the long run, there is little evidence of a negative abnormal buy and hold abnormal return (BHAR) after a reverse stock split, but there is some evidence BHARs varying by industry. An examination of financial ratios and variables reveals that firms with better sales performance and higher operating-income-to-assets have better ex-date returns. In the long run, firms with lower debt relative to their assets do better after the reverse stock split. Operating income expressed as a percent of assets is also positively related to the 250-day BHARs. The NASDAQ minimum bid price rule change of 2001 is explored to determine if it had an impact on reverse stock splits or delistings. The evidence is mixed. The number of firms delisted, expressed as a percentage of firms that would have been delisted under the old rules, decreased. However, the percentage of reverse stock splits, expressed as a percentage of low priced firms, did not change. xi CHAPTER 1: INTRODUCTION 1.1 Introduction and Motivation The wealth effects of reverse splits have been studied previously with little disagreement in the literature. The consensus of Vafeas (2001), Desai and Jain (1997), Han (1995), Peterson and Peterson (1992), etc. is that a reverse stock split is a negative informational event. Given the harmony of the literature, what is the purpose of another study on reverse stock splits? There are three reasons that further study is warranted. First, more data are available. As documented in Table 1 and Figure 1, reverse stock splits have been more frequent in the late 1990s and 2000s than in previous periods. Since 1992 the number of reverse stock splits has almost doubled. This is analogous to the number of smokers doubling after the Surgeon General has proven conclusively that smoking is bad for your health. Research has shown that the market reacts negatively to reverse stock splits, yet the number of firms using this strategy has dramatically increased. The research needs to be updated to determine if the reverse stock split is still followed by a negative market reaction. Perhaps something has changed in the way the market perceives the reverse stock split or perhaps there are valid reasons for a firm to consolidate its shares. Second, the type of firm that is reverse splitting its stock has changed over the years. In previous reverse split studies, most of the sample consisted of established firms that fell into financial difficulty. In recent years, perhaps a consequence of the Internet bubble burst, a new type of reverse splitting firm has emerged.1 In the months preceding the bubble burst, the initial public offering (IPO) market was at its peak. New technology-based and Internet-based firms were in high demand. After the bubble burst, many of these technology and 1 This refers to the beginning of the bear market of 2000 and 2001, when the NASDAQ composite fell dramatically. The beginning of this period of reversal is often referred to as the Internet Bubble burst. 1 Internet start-up firms lost a large percentage of their market value and their stock price fell below the minimum bid price required for continued listing. Some of these start-up firms chose to reverse split their stock in order to maintain compliance. Previous studies have examined reverse splits using primarily well established companies. Recent IPOs make up a large segment of this study.2 Third, a number of reverse splits with extraordinary post-reverse split performance have caught the attention of journalists who write for financial publications such as Forbes magazine. Journalists report that some reverse split stocks have experienced price increases of more than 100% in the months following the reverse split.3 They have speculated that a reverse split may not be the negative signal, or negative news event, that it was once thought to be. This study applies the rigors of academic research to the data to determine if these speculations are justified. Given the market rule changes, the changing composition of the sample, and perhaps a different dynamic in the market, results provided in this study may be beneficial to both regulators and corporate managers. The sheer number of reverse stock splits that have been announced during the past few years suggest that reverse stock splits are a strategic corporate decision that many managers now consider. Additionally, the 2001 change in the NASDAQ continued listing requirements that allowed low-priced firms more time to bring their bid price back into compliance (above $1.00) provides a unique opportunity to study the impact of such an event.4 In this dissertation, reverse stock splits are investigated on three fronts. First, the stock price reaction to the reverse stock split is examined. The reaction is examined in relation to certain firm characteristics and the reasons that a firm gives for reverse splitting. Daily abnormal returns around the announcement of 2 Based on a regression analysis that revealed that that the number of days since market listing is inversely related to the date of the reverse stock spilt. Coefficient –0.42 and p-value[...]... developed and tested in this dissertation to explore the stock price reactions to reverse stock splits The stock price reactions are examined in the context of the market environment, regulatory influences, the Internet Bubble burst, and the health of the stock as related to reverse stock splits 1.4.1 Stock Price Reactions The first hypothesis tested relates to the stock price reactions associated with reverse. .. FIGURES Figure 1 Reverse Stock Splits 1962-2002 144 Figure 2 Split Ratios of Stock Splits .145 Figure 3 Distribution of 250-Day Buy and Hold Returns .146 Figure 4 Buy and Hold Returns of Reverse Stock Splits .147 Figure 5 Market Adjusted Returns of Reverse Stock Splits 148 Figure 6 Matched Firm Abnormal Returns 149 x ABSTRACT Stock price reactions to reverse stock splits... limited sample size and the stability of bid price requirements in the NYSE and the AMEX, the focus of this dissertation regarding rule changes will be on NASDAQ stocks and the effects of these rule changes on reverse splits and low-priced stocks in general On September 27, 2001, NASDAQ issued a moratorium on the enforcement of the $1 minimum bid price rule in response to the depressed stock prices in the... to minimum bid price violators, but the NYSE and the AMEX had no such changes related to bid price or to any other criteria of interest to low-priced stocks In addition, the vast majority of the stocks in the later sample are NASDAQ stocks For example, in 2001 and 2002, there were no AMEX reverse splits and only five NYSE reverse splits per year In contrast, there were more than 100 reverse splits... higher price range after a reverse stock split results in lower percentage bid-ask spreads, and thus the transaction costs are lowered The lower bid-ask spread is probably due to the increased liquidity of the stock at its post reverse split price However, a possible lost tax savings after a reverse stock split can also be considered a “transaction cost.” Volatility decreases after a reverse stock split,... bid price As a result this change, low-priced firms had less incentive to reverse split their stock This study seeks to discover whether this rule change was effective 1.2 What Is a Reverse Stock Split? A forward stock split is the exchange of one share of stock for multiple shares For example, in a 2-for-1 split, each stockholder receives two shares for each share held, and in a 3-for-1 split, each stockholder... bid-ask spread is the same pre- and post-split, the lower price of the stock makes the bid-ask spread a higher percentage of the stock price 17 In an attempt to explain these varied benefits and consequences of stock splitting, the literature presents several reasons that a firm may reverse split its stock These reasons include asymmetric information, moving the stock s price to a more desirable trading... is a desirable price range in which their stock is more liquid Firms will split the stocks when the price gets too high and out of range for investors who must purchase shares in round lots.24 Firms will reverse split stocks when the price gets too low Margin requirements and institutional perception make moving up to a higher trading range look like an attractive option for low-priced stocks In addition... low-priced stocks A stock is viewed as more marketable if it is listed on a major market, and NASDAQ and the AMEX do not allow low-priced stocks to persevere In fact, a company is encouraged to reverse split if the stock trades at a low price for an extended period The NYSE does not have a minimum share price for continued listing, but it can delist companies in the case of unusually low share prices,... event of a reverse stock split There is no long-term stock price reaction associated with the event of a reverse stock split One facet of this study deals with the regulatory environment and one of the question of interest is whether the reverse splits were motivated by the threat of delisting If there is a difference in the returns for firms that have been forced to reverse split their stock versus