Introduction
Companies use their shares to raise and maintain capital for their operations. Financial managers may use stock dividends, stock splits, or reverse splits to manage financial situations within organizations. A stock dividend refers to an extra payment made to investors in the form of shares as opposed to the normal cash payments made by most organizations. A stock split refers to a situation where an organization increases the number of shares issued by a company above the normal amount to increase the company’s liquidity. As a result, stock splits lead to increased issuance of shares and decreased share prices. A reverse split is another financial management mechanism where a company combines its existing shares to reduce the company shares through mechanisms like cashing out of small shareholders.
Reasons for Issue Stock Splits and Reverse Splits
Companies mostly use stock splits as a strategy to meet specific goals that are perceived to benefit the company. In most cases, organizations use the strategy to enhance their liquidity, aiming to make the price of their shares more affordable and attractive. Through stock splitting, companies can attract many investors since they can obtain the shares at a lower price than the normal price before the split (Brooks, 2020). The mechanism is considered an effective tool to attain organization liquidity as it does not impact the individuals already shared with the company. The process is also perceived to significantly impact the organization’s value as it enables more people to become part of the organization (Brooks, 2020). This aspect is attained through the issuance of lower prices, motivating more people to buy the shares. Stock splits increase the demand for a company’s shares as it attracts more new buyers, which can be used for the organization’s benefit.
Reverse splits are considered critical in reducing the number of outstanding shares to accomplish a unique quantity of shares regarded as optimal. Reverse stock splits are mostly used to reduce the number of outstanding shares issued in the market (Brooks, 2020). Financial managers opt to utilize a reverse stock split to consolidate the number of shares it has issued into a few more valuable stocks. Such a practice is used to boost the prices of a company’s stock. In addition, a company may use a reverse stock split as a regulatory measure to prevent its stock from being delisted, especially when it is accused of irresponsibly issuing shares (Brooks, 2020). Through such a mechanism, a company can improve its visibility and image. Reverse split stock enhances the values of shares as their price increases due to the reduced number of outstanding shares. Some financial managers use reverse split stocks to attract the attention of key investors. This aspect is based on the fact that reverse stock split enhances the value of shares as they become stronger and higher.
Conclusion
Both stock split and reverse stock splits play a critical role in enabling organizations to attract more investors. However, while stock splits attract investors from the general public interested in becoming shareholders, reverse stock splits focus on wealthy investors. In such cases, the shares developed after a reverse stock split mechanism are likely to be identified by wealthy investors who want to invest in low but profitable stocks. Therefore, despite the mechanisms’ role in the share prices, the two processes’ outcome does not significantly impact the existing shareholders.
Reference
Brooks, R. M. (2020). Financial Management: Core concepts (4th ed.). Pearson.