How a Reverse Split Avoids Delisting

For a company, being "delisted" means having its stock taken off the exchange where it had been trading. Exchanges can delist stocks for several reasons, one of which is a low share price. To avoid the considerable damage a delisting can cause, a company may prop up a falling stock price by reducing the number of shares in public hands -- a tactic called a reverse stock split.

Listing Requirements

For a company's stock to trade on an exchange, such as the New York Stock Exchange or the Nasdaq, the company must meet the exchange's listing standards. These requirements have to do with the size of the company and how widely distributed its stock is. Once on the exchange, the company must meet "continuing" standards to remain listed. One of those standards is a minimum share price. Both the New York Stock Exchange and the Nasdaq, for example, require that a stock be trading for at least $1 a share.

The Dangers of Delisting

If a stock's price falls to the $1 range, the company is in danger of being delisted. Delisting can be devastating for a stock. The shares can still trade "over the counter," on electronic networks maintained by brokers and dealers, but once a stock disappears from an exchange, interest in -- and demand for -- the stock usually plummets. Many investors, including the large, cash-rich institutional investors that companies prize, prefer to deal only in exchange-traded stocks. A delisting often prompts a sell-off that drives the price down even farther. And the very fact of the delisting brings negative publicity to a company that can inflict heavy damage.

How Reverse Splits Work

A company can bolster its stock price with a reverse stock split. In a reverse split, the company cancels its current stock and issues its stockholders new shares -- but fewer of them. Say a company has 100 million shares outstanding, and those shares are selling for 90 cents apiece. If the company executes a "1-for-10" split, those shares will be replaced with 10 million shares with a value of $9 apiece. Stockholders receive one of the new shares for every 10 they owned of the now-canceled stock. The total value of any investor's stake in the company doesn't change; that value is just spread out over fewer shares. This accounting maneuver pushes the share price out of the delisting danger zone. In general, the market doesn't look kindly on reverse splits, because they increase the stock price artificially, without addressing the problems that caused the price to sink in the first place.

Minimum Share Requirements

In theory, a company could pull off one reverse split after another to keep propping up a sinking price and hold onto its exchange listing. But doing so raises another delisting risk. Exchanges' continuing standards usually include a required minimum number of shares in public hands. Nasdaq, for example, requires companies to have at least 1.1 million shares owned by the public, or 750,000 under certain circumstances. Since each reverse split reduces the number of shares outstanding, the minimum share requirement puts a limit on reverse splits as a repeatable tactic.

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