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November 6, 2002 -- News Brief

Reverse Stock Splits Making News: Ikenberry Study Cited

Research by David Ikenberry, professor of finance, was cited recently by both the Wall Street Journal and the New York Times. Ikenberry and and Sundaresh Ramnath, assistant professor of accounting at Georgetown University, collaborated on a theory about reverse stock splits that was published earlier this year by The Review of Financial Studies.

Ikenberry and Ramnath's study was cited by Dennis Berman in the October 21 edition of the WSJ in an article focusing on Lucent Technologies announcement that it was considering a reverse stock split to increase its share price from 68 cents per share to over $1. Lucent considered this move to prevent the company from being "delisted" on the New York Stock Exchange. Ikenberry was quoted as saying that such a move "confirms investors's fears that the possibility of raising the stock price naturally is not going to happen."

In the November 3 edition of the Times, Ikenberry and Ramnath's study is cited as the source of a theory about the "confidence factor" in reverse stock splits. Mark Hulbert was covering plans for reverse stock splits announced by Lucent Technologies and Nortel Networks and a split implemented in mid-October by Palm, Inc. Hulbert cited the work by the research team, who postulated that when management is not optimistic about a stock's future performance, a reverse split is often used to increase the price per share. When management is optimistic that the extremely low price per share will eventually rise, the stock is left alone.

Both articles are available online to subscribers of the Wall Street Journal and the New York Times.

Ikenberry and Ramnath's journal article is available in PDF format for downloading. The abstract is below:

An emerging literature looking at self-selected, corporate news events concludes that markets appear to underreact to news. Recent theoretical articles have explored why or how underreaction might occur. However, the notion of underreaction is contentious. We revisit this issue by focusing on one of the most simple of corporate transactions, the stock split. Prior studies that report abnormal return drifts subsequent to splits do not appear to be spurious, nor a consequence of misspecified benchmarks. Using recent cases, we report a drift of 9% in the year following a split announcement. We consider fundamental operating performance as a source of the underreaction and find that splitting firms have an unusually low propensity to experience a contraction in future earnings. Further, analysts' earnings forecasts are comparatively low at the time of the split announcement and revise sluggishly over time. Together these results are consistent with the notion of market underreaction to the information in corporate news events.

Rev Fin 2002; 15:489-526
© 2002 the Society for Financial Studies

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