As the name suggests, a reverse stock split is the polar opposite of a standard stock split. A stock split increases the number of available shares by giving investors a certain number of shares (generally 2) for their one share. This then would in this scenario half the price of the stock, but double the number of shares thereby not altering the current company valuation. A reverse stock split is when the investors see their shares halved (generally speaking but it can be any number the company deems necessary) but the value of the shares doubled to maintain current value. An alternative name for this action is a “stock merge”.
Generally a reverse split cannot occur without a meeting of a board of directors and/or shareholders since this does directly affect the investors in the company. Often times a reverse stock split is seen as a weakness within a company seeking to artificially inflate its apparent value to outside companies by way of increasing its stock price at the cost of shares. While this move does show current weakness within the financial prospectus of the company, it can lead to stronger performance down the road as many mutual funds and institutional investment firms will not invest in a stock below a certain price. If a company feels they need to attract these types of investors they can seek a reverse split as an option.
In extreme cases, a reverse split can be used to keep a company from becoming delisted on it’s exchange. If the price of the stock has fallen below a critical level such as below a dollar, the reverse split could be used at say, 10 to 1, to bring the price of the stock back above 10 dollars. This will allow the company to continue to trade on it’s exchange which again could foster further growth, or just be staving off the inevitable financial collapse of the company.