Understanding Reverse Stock Splits: Why Companies Implement Them and What It Means for Investors

The Core Mechanics of a Reverse Stock Split

When a company faces pressure from declining stock valuations, one corrective action it might take is executing a reverse stock split. Unlike the more common forward stock split seen with companies like Amazon and Alphabet in 2022, a reverse stock split consolidates outstanding shares into a smaller number of shares at a higher price per share. The math is straightforward: if a company announces a 1-for-20 reverse stock split, every 20 existing shares become one share post-split.

Calithera Biosciences provides a concrete illustration. The South San Francisco biotech firm announced its 1-for-20 reverse stock split in June, which took effect on June 14. The company possessed approximately 78.5 million outstanding shares before the consolidation; post-split, that number contracted to roughly 4.9 million shares. Shareholders holding fractional shares receive cash compensation calculated at the prevailing stock price at the time of the split.

Why Corporations Choose This Path

The primary driver behind reverse stock splits revolves around regulatory compliance. Stock exchanges like Nasdaq impose minimum bid price requirements, typically $1, to maintain listing status. When a company’s stock trades below this threshold for an extended period, it risks delisting—a prospect no company welcomes given the loss of visibility, credibility, and trading liquidity that follows.

Calithera’s decision directly addressed this concern: bringing its stock price back above the $1 minimum threshold would preserve its Nasdaq listing privileges. Beyond regulatory survival, some organizations employ reverse splits as a perception tool, attempting to attract institutional capital that avoids low-priced stocks on principle. There’s also a strategic variant: companies planning spinoffs sometimes implement reverse splits beforehand to position their equity divisions for better valuations in the separation.

The Regulatory Framework and Shareholder Process

Once a company’s board approves a reverse split, disclosure follows through press releases or SEC filings (Form 8-K, 10-Q, or 10-K). In cases requiring shareholder approval, the company must file a proxy statement on Schedule 14A. If the reverse split would result in the company going private, additional filings like Schedule 13E-3 become mandatory. State corporate law and each company’s bylaws ultimately govern the specifics of this process.

What Actually Changes—And What Doesn’t

Here’s where investor psychology matters most: the company’s intrinsic market value remains constant. If you owned 1% of a company before the reverse split, you still own 1% afterward. The number of shares shrinks, their individual prices rise proportionally, but the overall market capitalization doesn’t budge. What does shift is investor perception.

General Electric exemplifies this complexity. In August 2021, GE implemented a 1-for-8 reverse split to address an unusual structural problem: after years of divestitures, the company had accumulated 8.8 billion outstanding shares—far exceeding peer averages among industrial firms. Rather than signaling distress, GE’s action corrected a quantitative imbalance created by decades of portfolio restructuring.

The Perception Problem

Investors overwhelmingly associate reverse splits with struggling enterprises. Market sentiment typically treats these announcements with skepticism, viewing them as distress signals rather than routine corporate actions. This perception gap matters: while the fundamental economics remain neutral, the reputational sting can pressure stock performance short-term.

However, blanket pessimism misses important context. Sometimes reverse splits buy time for turnarounds, resetting investor perception before fundamental improvement materializes. Other times they’re structural housekeeping, as with General Electric’s scenario. The critical step for investors involves investigating what prompted the action rather than reflexively selling based on headline reaction alone.