A stock split is an increase in the number of a company’s outstanding shares while proportionately decreasing each individual share’s book value by decreasing the par or stated value of the shares, without any transfer from the retained earnings account to the paid-in capital accounts. The most common reason for a split is to cause a large decrease in the market price per share. In a traditional stock split, the number of shares outstanding is increased, while the par value per share decreases, a two-for-one (2:1) split, for example, doubling the shares outstanding.
The par value per share is reduced pro rata so that the total value of the capital stock account remains the same. A split may effectively be achieved through a stock dividend without a change in the stock’s par value, whereby additional shares are issued for which the firm receives no assets (i.e. cash). A stock split involves no capitalization of earnings.
| Effects of a Stock Split (Example) | |
| XYZ is trading at $40 per share and has 10 million shares issued and outstanding. The company implements a 2-for-1 stock split. | |
| Market capitalization before split ($40 x 10mn) | $400,000,000 |
| Price per share after the split [$40/(2/1)] | $20 |
| Number shares outstanding after split [10mn/(2/1)] | 4,000,000 |
| Market capitalization after split ($20 x 20mn) | $400,000,000 |
A reverse split is a decrease in the number of issued shares of a company’s stock while proportionately increasing each individual share’s book value and achieved by increasing the par or stated value of a company’s shares. A company may undertake a reverse split to significantly increase the market price of its issued and outstanding shares, commonly to qualify for trading on a regulated market (e.g., to meet the listing requirements of an exchange) or maintain the price per share within the desirable trading range. In a reverse split, the par or stated value of the reduced number of shares increases in proportion to the reduction. Reverse splits are quite unusual.