Corporate Action refers to an action at the corporate level that directly impacts the financial structure of a company, its assets, and its stakeholders. The impact of a Corporate Action could be a negative impact or positive impact. Corporate Actions tell you a lot about a company’s financial health and structural and operational stability. All significant Corporate Actions must be approved by the board of directors and authorised by its shareholders.
Corporate Actions can fall into one of the following three categories:
1. Voluntary Corporate Actions:
Voluntary Corporate Actions are Corporate Actions in which shareholders can opt to participate. For the company to move forward with the initiated Corporate Action, it must get a positive response from a majority of its shareholders. A good example of a Voluntary Corporate Action is a tender offer.
2. Mandatory Corporate Actions:
Mandatory Corporate Actions are initiated and approved by the company’s board of directors. Shareholders do not have any say in these actions. However, they are impacted as beneficiaries. Some examples of Mandatory Corporate Actions include stock splits and mergers.
3. Mandatory Corporate Actions with Options:
Mandatory Corporate Actions with Options refer to Mandatory Corporate Actions that are initiated and approved by the company’s board of directors. However, these Corporate Actions offer the shareholders a choice between different options, with one being a default option. An example of a Mandatory Corporate Action with Options is a company issuing dividends to its shareholders, where the shareholders have the choice to receive the dividend in the form of stock shares or Cash Dividends, with stock shares being the default choice in case the shareholder doesn’t submit a choice.
Primary Purpose of Corporate Actions:
All Corporate Actions implemented by companies can be mapped to two primary purposes. They have been given below for your clarity.
- Impacting the Share Price: If the share price of a company is too high or too low, then the liquidity of the stock is largely impacted. If the share price is too low, then the stock can be looked upon as a penny stock. On the other hand, if the share price is too high, the stock becomes unaffordable for small investors. Some Corporate Actions such as Buyback of Shares, Stock Splits, and Reverse Stock Splits, are implemented to influence the share price of the company’s stock prices.
- Corporate Restructuring: When a company wants to restructure its business to grow its profitability, it undertakes Corporate Actions such as Mergers and Acquisitions and Spin-Offs.
What are Some Common Corporate Actions?
While Corporate Actions sound complex, they are not complicated to understand. Whether you have just started your journey in the investment field or want to acquire more clarity about various Corporate Actions, we have simplified some Common Corporate Actions below that impact a company’s stock prices and directly or indirectly impact your investment portfolio.
1. Dividend (Mandatory Corporate Action with Options)
A company can issue Dividends either in the form of Stock Dividends or Cash Dividends. Usually, Dividends are paid to the shareholders at the end of specific periods such as annually, semi-annually, or quarterly. Dividends are a share of the company’s profits paid to the stock owners. Dividend payouts impact a company’s equity. The distributable equity (paid-up capital or retained earnings) gets reduced.
Cash Dividend: Cash Dividend Pay Out means that every shareholder gets paid a certain amount of money for every share they hold. For example, if a shareholder owns 100 shares of a company, and the company announces a cash dividend of Rs. 100 per share, the owner shall receive Rs. 10,000 as Cash Dividend.
Stock Dividend: Stock Dividend Payout refers to a Dividend paid to the shareholders in the form of stock instead of cash. For example, if a company announces a Stock Dividend of 10%, then a shareholder holding 100 shares will receive 1 extra share for every 10 shares owned. This means this shareholder will receive 10 shares in total as a Stock Dividend Payout.
Purpose of Dividend:
The purpose of announcing Cash Dividends is to signal to investors that the company has a good amount of retained earnings that directly benefit the shareholders.
The purpose of the Stock Dividends announcement indicates a decrease in the company’s stock price and a dilution of the earnings per share. However, it still communicates to the investors the certainty about the company’s well-being.
2. Stock Split and Reverse Stock Split (Mandatory Corporate Action)
Stock Split refers to Corporate Action where a company splits the number of stocks its shareholders hold. This means while the number of shares for each shareholder increases, the market capitalisation or the investment value for each shareholder remains unchanged.
A Reverse Stock Split is exactly the opposite of a Stock Split. Here the number of outstanding shares is decreased to increase the share price without changing the overall investment value of each shareholder.
Purpose of Stock Split and Reverse Stock Split:
The objective of a Stock Split is to increase the liquidity of the stock and make it more affordable for small investors.
The main motive of a Reverse Stock Split is to enhance the company’s reputation and liquidity of the stock.
3. Bonus Issue (Mandatory Corporate Action)
Bonus Issue is a form of a Stock Dividend. Bonus Issue means bonus shares issued to the company’s current shareholders out of the company’s reserves. These are free shares that shareholders receive against the shares they already own. Bonus Issue is usually allotted in fixed ratios such as 3:1, 2:1, or 1:1. When Bonus Shares are issued, the number of shares owned by a shareholder increases. However, the value of the total shareholdings remains the same.
Purpose of Bonus Issue:
Some of the intended objectives of issuing Bonus Shares include the following.
- Increase the liquidity with the increase in the number of outstanding shares.
- Increase and encourage the participation of retail investors with a significant share price decrease in proportion to the Bonus Shares.
- Increase the capital base of the company.
4. Rights Issue (Voluntary Corporate Action)
Rights Issue is another common Corporate Action that you should know about. A company that implements a Rights Issue is essentially offering new or additional shares to its existing shareholders. This means that the current shareholders of the company are offered the right to receive or purchase these shares before they are offered to the public.
Purpose of Rights Issue:
The main motive of the Rights Issue is to raise additional capital for the company without increasing its debt-to-equity ratio. Rights Issue usually indicates that the current shareholders of the company are allowed to leverage a promising new development.
5. Buyback of Shares (Voluntary Corporate Action)
Buyback of Shares is a method for a company to invest in itself by buying its shares from other market investors. Buybacks decrease the outstanding number of shares in the market. It is, however, a significant corporate restructuring method. Buyback of Shares is one of those Corporate Actions that indicate a company’s confidence in itself. This impacts the company’s share price positively.
Purpose of Buyback of Shares:
Some reasons for buybacks are as follows.
- Prevention of another company from taking over.
- Improvement of profitability of the company on a per-share basis.
- Prevention of the share price from reducing in the stock markets.
- Showcase the confidence of the promoters in the company.
- Consolidation of stake in the company.
6. Mergers and Acquisitions (Mandatory Corporate Action)
A Merger is when two or more companies merge to increase their scale of operations and profitability. They essentially synergise to form a new company. In this scenario, the existing shareholders of the merging companies maintain a shared interest in the new company.
An Acquisition is when a larger company acquires a smaller company for further expansion. In this, the event the target company ceases to exist, however, the acquirer takes over the target company’s business, and the stocks of the acquirer continue to be traded in the stock market.
Purpose of Mergers and Acquisitions:
Here are a few objectives behind Mergers and Acquisitions.
- Mergers and Acquisitions are often implemented to eliminate anticipated or current market competition.
- Implementation of Mergers and Acquisitions are implemented to increase the overall efficiency of the company in the current market scenario.
- Mergers and Acquisitions are made to grow the company’s market share without doing any significant heavy lifting.
7. Spin-Offs (Mandatory Corporate Action)
Spin-Offs lead to the creation of an independent company through the distribution of new shares of an existing business. In simple words, it’s a type of divestment.
Purpose of Spin-Offs:
Some reasons for Spin-Offs are as follows.
- A company can opt for a Spin Off if one of its segments is underperforming. Spinning it off can raise the potential and the value of the parent company by getting rid of its weakness.
- A company can also implement Spin Off if one of its segments is outperforming, and declaring it as a separate legal entity can prove beneficial to the parent company.
- If a company wishes to sell off a segment of its business, it may opt for a Spin-Off to sell off that segment separately, keeping the rest of the business intact.
8. Tender Offer (Voluntary Corporate Action)
A Tender Offer is a bid to buy some or all of the shareholder’s stocks in a corporation. Usually, a Tender Offer is typically made publicly to invite shareholders to sell their stocks for a specific price and within a particular time frame. Usually, a premium price is offered in comparison to the market price, and it is usually contingent based on a minimum or a maximum number of shares sold. An example of a Tender Offer is a Takeover Bid.
Purpose of Tender Offer:
- The various purposes of implementing a Tender Offer are as follows.
- To support the price of stocks during a period when the market condition is slow.
- To give another way out to the shareholders when there is low value on the shares being traded.
- To improve on the price per stock.
- A company may make a Tender Offer to existing shareholders to buy back a quantity of its stock to regain a larger equity interest in the company and as a way to offer an additional return to shareholders.
Corporate Actions may have a massive impact on the stocks and can convey a lot to the shareholders of a company about the company’s financial health, operational stability, and future growth potential. Hence, as an investor and shareholder, it is essential to have in-depth knowledge and a clear understanding of the different types of above-mentioned Corporate Actions, their purposes, and how they impact you. To profit from Corporate Actions, investors are required to keep an eye on all the related updates. However, if you sign up with Eureka, you shall receive regular notifications related to all upcoming Corporate Actions and other significant news from the financial world to help you make the best of your invested funds. To know how to use various Corporate Actions to your advantage and enhance the value of your investment portfolio with them, Connect With Us Now.
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