A reverse stock split consolidates stocks at a certain ratio and reduces the number of shares outstanding while increasing the value of each share, as opposed to a regular stock split, which divides existing stocks into more shares which are worth less apiece.
A normal stock split, which increases the number of shares an investor owns without increasing the total value of his or her interest in the company, has the benefit of increasing liquidity with the shares and possibly narrowing the bid/ask spread. A reverse stock split reduces the number of shares in circulation by effectively combining the existing shares at a certain ratio (such as, 2 shares now equals 1 share).
A reverse split tends to suggest that a stock price has declined, as one reason to merge shares is to satisfy an exchange’s minimum stock price (such as $5 per share), so reverse splits have a negative connotation. A shareholder who does not hold enough of the old shares to own one of the new larger shares will receive a cash settlement instead.
This can reduce the number of shareholders and possibly help a company fit into a different regulatory category with the SEC and possibly reduce the company’s reporting requirements. It is also called a stock merge.
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