Category: Study Question

This week’s study question from the Solomon Online Exam Simulator question database is now available.

Question (Relevant to the Series 7, Series 62, Series 65, Series 79, Series 82, and Series 99):

A reverse stock split:

I. Reduces the value of shareholder equity

II. Requires SEC approval

III. May be done to maintain an exchange listing and to attract institutional investors

IV. Can result in fewer shareholders

Answers:

A. II, III

B. III, IV

C. I, II

D. I, IV

Correct Answer: B. III, IV

Rationale: A reverse stock split is the opposite of a stock split, so instead of ending up with more shares in the case of a stock split, in a reverse stock split shareholders end up with fewer shares. For example, in a 1 for 3 reverse split, shareholders receive one new share for three old shares, but the value of each share increases proportionately resulting in an increase in the value of each share but no change in the value of shareholder equity. The increase in the share price is a primary reason for reverse stock splits; a common reason for the reverse split is to keep a share price above some exchange-required minimum share price, such as $1. A higher share price is also desirable because it can broaden the base of potential investors to include institutions which may be prohibited from purchasing low-priced stocks. Stock splits are governed by state law and by company bylaws, they do not require SEC approval. Reverse stock splits that involve large reductions in the number of shares, for example a 1 for 100 reverse split, may result in shareholders not having enough of the old shares to exchange in return for the new shares, when this happens the shareholders are paid cash for their shares. This results in an overall reduction in the number of shareholders.

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