An Event Study of Reverse Stock Splits in Hong Kong Market
32 Pages Posted: 4 Jun 2003
I use event date methodology to examine the market reaction to reverse stock splits in Hong Kong market from 1991 to 2001. I first investigate the prospectuses distributed by reverse-splitting firms. Four major reasons are provided in firms' prospectuses: 1. Reverse splits will reduce transaction costs for dealings in the consolidated shares; 2. Reverse splits will improve the flexibility in pricing new issue when needed; 3. Share consolidation should raise the profile of the company among institutional and international investors; 4. Directors believe there exists a favorable stock price range, and reverse splits are therefore be used to bring the market value of the shares into a range that the firms consider more appropriate. I find that the abnormal returns around the announcement date are negative and small firms have stronger negative reaction. This result is consistent with the event studies in the U.S. market [Lamoureux and Poon (1987), Peterson and Peterson (1992)]. However, this negative response is contrary to the results in Canada where market reacts positively with a cumulative abnormal return of 9.3 percent on the announcement date that is thereafter maintained [Masse et al. (1997)]. No significant market response to the ex-date is observed. The adjusted trading volume increases considerably after reverse splits. This result partially suggests that the reverse stock improve the liquidity of the stock. The majority of the reverse-splitting firms do not change their board lot size after splits, they therefore reduce transacting costs. The relative tick sizes, which also affect the transaction cost, decrease significantly after splitting. My analysis of the cross-sectional distribution of the split factor provides no support for the "optimal stock price range" hypothesis. Hence, the reverse stock splits can be viewed as a passive reaction to a decayed firm performance rather than an active means to achieve a specific objective.
Keywords: reverse stock split, abnormal return, trading volume, tick size, optimal stock price range
JEL Classification: G14, G32
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