Understanding Reverse Stock Splits: Why Companies Execute Them and What Investors Should Know

The Strategic Reason Behind a Reverse Split

When a company’s stock price plummets below critical thresholds set by major exchanges, management faces a dilemma: maintain compliance or risk delisting. This is where a reverse split becomes a critical tool. Rather than being a sign of strength like a traditional stock split, a reverse split consolidates outstanding shares into fewer units, effectively raising the per-share price on paper.

The primary motivation is survival on major exchanges like Nasdaq. Maintaining a listing on these platforms provides visibility, credibility and liquidity that struggling companies desperately need. Delisting carries significant reputational damage that few organizations can afford.

Consider Calithera Biosciences (NASDAQ: CALA), which announced a 1-for-20 reverse split in June to address declining share prices. The company needed to push its stock above the $1 minimum bid price requirement mandated by Nasdaq. Before the reverse split took effect on June 14, Calithera held approximately 78,468,000 outstanding shares. Post-consolidation, this number was expected to shrink to around 4,865,000 shares, excluding options and warrants.

How the Reverse Split Mechanics Actually Work

A reverse split operates through a specific consolidation ratio that combines multiple pre-split shares into fewer post-split shares. In Calithera’s case, every 20 existing shares became 1 share. This mathematical adjustment immediately elevates the nominal stock price without changing the company’s actual market value.

What happens to partial shares in this process? Companies typically issue cash payments to shareholders holding fractional amounts. Calithera followed this standard practice, compensating fractional shareholders based on the prevailing stock price at the time of consolidation.

Additional Motivations Beyond Compliance

While maintaining exchange listing is the primary driver, companies pursue reverse splits for several other strategic reasons. Some use the action to enhance corporate image and attract institutional investors who avoid low-priced stocks. Others implement a reverse split before executing a spinoff, as the elevated share price creates more favorable conditions for the subsidiary’s valuation.

General Electric (NYSE: GE) provides an instructive example. In August 2021, the industrial conglomerate executed a 1-for-8 reverse split. GE’s rationale: decades of divestitures had reduced the company’s asset base without proportionally reducing share count, leaving it with 8.8 billion shares outstanding—far exceeding typical share counts of comparable industrial corporations. The reverse split realigned the share structure with the company’s scaled-down operations.

Market Perception and Stock Performance Dynamics

Here’s the critical distinction: while a reverse split doesn’t alter a company’s market capitalization or fundamental intrinsic value, it fundamentally reshapes investor psychology. Shareholders’ total stake remains mathematically identical, but the share count decreases proportionally.

Investors traditionally interpret reverse splits as bearish signals—a perception often justified. The action typically signals financial distress or a struggling business. However, this perception isn’t universally accurate. Some companies execute reverse splits as tactical maneuvers during turnaround efforts, buying time to demonstrate improved operational performance before perceptions fully solidify.

The Regulatory and Approval Framework

State corporate law, company bylaws, and SEC regulations collectively govern reverse split authorization. After board approval, companies must notify shareholders through press releases or SEC filings (Forms 8-K, 10-Q, or 10-K). Situations requiring shareholder approval trigger proxy statement filings on Schedule 14A. If a reverse split would force the company into private status, Schedule 13E-3 filings become mandatory.

Final Perspective for Investors

The automatic instinct to sell following a reverse split announcement warrants reconsideration. Rather than categorical rejection, investors should investigate the underlying catalyst. Understanding whether management is addressing technical compliance issues, executing a strategic repositioning, or managing genuine operational challenges requires due diligence. A reverse split isn’t inherently negative—context determines investment merit.