The term ‘corporate actions’ is one of the most crucial terms in the world of business and finance. The term holds immense relevance and value to anyone right from the CEO of a large corporation to the smallest of stockbrokers. A single corporate action can turn a company’s future on its head, for better or for worse. Since it is one of the essential concepts to be understood by anyone with the remotest interest in stock markets and shares, here is this humble attempt to elucidate it in simple terms for anyone eager to learn. Here we shall be looking at what is meant by corporate actions, their importance and relevance, different types of corporate actions with examples, how they impact the share market, how they are undertaken, and more.
What are corporate actions?
A corporate action is generally one that is initiated by a joint-stock company and can have an effect or material impact on its stakeholders. They usually follow a decision taken by the board of directors of the company with the approval of the shareholders. A corporate action can be something as minor as a change of name of the company that has little impact on its financial health. On the other hand, it can also be crucial like a merger decision or financially decisive one like the distribution of dividends or bonus to the shareholders. Depending upon the type of corporate action, it can either alter the value of the company’s share capital or keep it unchanged. A majority of corporate actions, in general, will serve as reflections of the company’s financial status and health. Those keenly observing the changes and fluctuations taking place in the share-market scenario can easily evaluate a company’s financial position and decide whether its shares are reliable or not by viewing the corporate actions initiated by it.
Why are corporate actions important?
Now that you have the basic idea of what a corporate action is, a question of curiosity, “What are different corporate actions?” must be popping up in your mind. However, before discussing it, let’s first try to answer the question ‘Why does corporate action happen?’ In other words, what are the reasons that compel a company to initiate such actions? There could be numerous reasons for a company to undertake a corporate action. Let’s see.
No business entity can function isolated from its environment. It means that it is constantly in interaction with its environment and needs to adjust to any changes that occur in it. For a company to survive and thrive, it needs to take initiatives in response to a change in its environment. For example, a medical equipment company manufacturing manual BP apparatuses may decide to merge with an electronic device manufacturer when it senses an increased demand for electronic BP apparatuses along with a decline in the demand for the manual ones.
Even when there is no sudden change in the environment, a company can undertake corporate actions. It could be a part of the company’s long-term plans and strategy. Based on the strategy, a company can initiate various corporate actions regularly such as the annual distribution of dividends or depending on various business dynamics.
Similarly, there can be many more reasons why a company initiates different corporate actions. Even when a company is about to wind up, it will have to resort to certain corporate actions for fulfilling legal formalities.
What are types of corporate actions?
All the minor and major corporate actions together can form a lengthy list. For convenience, they are often classified into different types. They may be classified as mandatory and voluntary corporate actions. They can also be classified as actions that have a financial impact on the shareholders and those that don’t have any. There can be corporate actions involving a new entity such as merger corporate actions or takeovers. However, the corporate actions that are considered the most decisive are the ones involving a financial impact. Here, let us see what are types of corporate actions in detail, especially the ones involving financial impact.
Usually, dividends are a fraction of a company’s profit distributed among the shareholders. However, some companies may pay dividends in special cases even when there is no profit. It is not mandatory for any company to pay dividends to the shareholders. Instead, the profit value will be reflected in the value of the shares held by the shareholders. For instance, in June 2020, Qualcomm Incorporated, a leading telecommunications manufacturer, paid a dividend of $0.65 per share while another company, Square Inc., does not pay any regular dividends to the shareholders.
When a company pays you a dividend, it actually pays you the cash equivalent of a portion of the share value you hold. It will bring down your share value by that amount. Suppose you hold 100 shares of $25 each in a company, you have shares worth $2500. After one year, supposing the company gets a profit of 10%, your share worth is increased by 10%. i.e., you now hold $2500 + $250 = $2750 worth of shares. If the company decides to pay half of the profit as dividend, it means you get $125 as a dividend. This amount is taken from your share value. Thus, after you receive the dividend as cash, the remaining share value you have is $2750 – $125 = $2625. The following table illustrates this.
|Value per share||No. of shares you hold||Total value of shares you hold||Company’s profit percentage||Profit value on your shares||Total share value after adding profit||Dividend (Half of profit, in this example)||Remaining value of shares after paying dividend|
|$25||100||$2500||10%||10% of $2500 = $250||$2500 + $250 = $2750||$125||$2750 – $125 = $2625|
It is important to know the terminology of certain dates related to dividends.
- Dividend declaration date: This is the date on which the board of directors conducts a meeting and decides to issue the dividends.
- Record date: On this date, usually around 30 days following the declaration, the shareholder profiles in the company register are reviewed to shortlist those eligible for dividends.
- Ex-dividend date: Also known as Ex-date, this usually falls two days before the Record Date as the dividend issue is done on T+2 basis. The relevance of the Ex-date is that shareholders holding shares before this date alone are considered for dividends.
- Dividend pay-out date: It is on this date that the actual dividends are paid to the eligible shareholders in the register.
Different companies pay dividends during different times of the year and at different intervals. Based on it, dividends can be called by different names as mentioned below.
- Final Dividend: Some companies may distribute the dividend regularly once every financial year. Such dividend paid at the end of the financial year is known as the final dividend.
- Interim Dividend: It is paid at any time other than the end of the financial year.
- Trailing Twelve Months (TTM) Dividend: This is the dividend paid by calculation based on the last twelve consecutive months, which is a full year but doesn’t exactly coincide with the financial year period.
2. Bonus issue
Bonus is considered a reward the company pays the shareholders out of its reserves. It is a form of Stock dividends as no cash payment is done. This is in the form of additional shares based on a ratio or multiple of the number of shares already held by each shareholder. Suppose, the bonus is 2:1. Then the shareholder will get 2 additional shares for each share held by him/her. However, the total share value will not increase or decrease as the value per share is adjusted proportionately. i.e., if you hold 100 shares of $10 each, it becomes 300 shares of $3.33 after bonus issue. See the following table. The total share value remains unchanged at $1000.
|Bonus ratio||No. of shares held before bonus||Value per share before bonus||Total share value before bonus||Share value after bonus||No. of shares held after bonus||Total share value after bonus|
As the value per share comes down with a bonus issue, the company usually becomes accessible to smaller investors. Also, since the parameter of the issued share capital of the company looks attractive, it gains a better profile. However, its reserves have to face some depletion. The action doesn’t need an election as the total share capital remains unchanged.
This is a corporate action similar to a bonus and often confuses some investors between the two. However, it has its subtle differences. Stock-split is nothing but splitting the existing stock into factors. When the face value of a share stays at a very high level, it is advantageous to have a stock-split as it can make the price of shares affordable to more investors. For instance, a stock-split of 1:2 implies that a share is divided into two. With this division, the face value of shares also gets divided accordingly. However, the total number of shares now increases to double. A simple example is the stock-split of the shares of Britannia Industries in the ratio 1:2 in 2018. The face value was Rs. 2 per share, which became Re. 1 after the split. And the total number of shares changed from 250 million to 500 million to maintain the total stock capital of Rs. 500 million. See the table below.
|Initial face value of share||Total no. of shares before split||Total stock value before split||Stock split ratio||Face value of share post-split||Total no. of shares post-split||Total stock value post-split|
|Rs. 2||25 million||Rs. 50 million||1:2||Re. 1||50 million||50 million|
So how is stock-split different from the bonus issue? The main difference is that a bonus is issued using additional shares while in a stock-split, the increase in the number of shares occurs by splitting the existing number of shares. Also, the issued share capital remains unchanged with a stock-split, unlike in a bonus issue.
4. Rights issue
Rights issue is issuing additional shares to the existing shareholders. This is usually done to generate additional capital. Though it is similar to issuing fresh shares through an IPO (Initial public offering), in this case, the shares are not issued to the public. It is only offered to the existing shareholders. If the ratio of the rights issue is 1:5, it means that you are eligible to buy 5 shares for every share you hold. Unlike any of the corporate actions listed above, the rights issue requires the shareholders to pay money to buy the additional shares. Since the transaction takes place directly between the company and the individual shareholders, the fresh shares usually cost comparatively less than the market price. A rights issue can be an indication of the company’s prosperity and stability as it is confident enough to generate new funds to expand the business into new arenas.
5. Buyback of shares (Tender offer)
Buyback is the process in which the company purchases back some of its own shares from the shareholders. This could be an indication that the company has a healthy cash reserve. Buyback is performed by making a tender offer to the shareholder. There can be multiple reasons why a company undertakes a buyback. A buyback can result in any of the following outcomes:
- Consolidation of the company’s stakes
- Preventing the share price in the market from going too low
- Creating a demand for the shares in the market thus increasing its price
- Preventing other stakeholders from taking over the company
Now, what is a merger corporate action? Sometimes, two companies can merge to become a single new entity. The resulting company is called a merger. It is a corporate action different from the ones like dividends or bonus issues. It transforms the entire profile of the companies involved. In 1998, Daimler AG, the German automobile corporation, and Chrysler, the US automotive manufacturer, merged to form the DaimlerChrysler AG. This way, the best of both companies can be utilized for the advantage of the business. It results in the benefits of better economies of scale, chances for diversification, bigger market share, increased sales, etc.
The above listed are some of the major and most common corporate actions. They are not all. There are many more corporate actions such as warrants, conversion, takeover, consolidations, etc.
What are Mandatory and Voluntary corporate actions?
Though we discussed various types of corporate actions, they can all be classified under two broad groups, namely, Mandatory corporate actions and Voluntary corporate actions.
- What are the mandatory corporate actions? – Those are corporate actions that are mandatory for the shareholders to participate in. There is no option for the shareholder to stay away from such corporate actions. Cash dividends, bonus issue, stock-splits, mergers, etc. are all examples of mandatory corporate actions. A ‘mandatory corporate action with choice’ is one that gives certain options to the shareholder in dealing with the mandatory action.
- What are voluntary corporate actions? – In contrast to mandatory corporate actions, voluntary corporate actions are those which the shareholders have the freedom to either participate in or ignore. Examples are rights issue, buyback of shares, delisting the company, etc. The shareholder is under no obligation to participate in such actions if he/she doesn’t want to.
How do corporate actions affect the share market?
Armed with sufficient knowledge about the various corporate actions from the discussion so far, let’s now try to answers certain very important questions such as “How corporate actions affect share prices?” as such are the questions investors are concerned about the most when they think about corporate actions.
Corporate actions can have a serious impact on shareholders and bondholders financially, though not all. The explanations to the question “How do corporate actions affect stock price?” may not always be convincing to some investors since the impact may not be direct or immediate. Certain corporate actions can bring indirect financial impact too. Let’s now have a brief look at the impacts some of the above corporate actions can have on the share market.
- Dividends: The value per share decreases as the dividends are nothing but cash paid to the shareholders after taking out some amount from the shares they hold.
- Bonus issue: The main impact of issuing bonuses is again the reduction of the share prices as the number of shares is increased without changing the total value of shares. The reduction is proportionate with the bonus ratio.
- Stock-split: A stock split also immediately causes a drop in the share value by the proportion of the split. It can also cause more liquidity which may bring down the stock prices at a subsequent point in time.
- Rights issue: As the number of available shares in the market increases with a rights issue, there is a dilution in the stock price and a high likelihood of share prices going down.
- Buyback: The buyback creates an increase in demand for the shares as the availability of the outstanding shares becomes less. This can create a sudden increase in the market share price for a short time.
Corporate actions and it’s impact on NAV
Since NAV (Net Asset Value) of an entity is its total assets minus the liabilities, any corporate action that affects the assets of the entity can also affect its NAV. It will be reflected on the NAV of the company on the date a particular corporate action takes place. Hence the effect of corporate actions such as dividends, buyback, etc. must be taken into consideration while calculating the value of NAV anytime.
How are corporate actions undertaken?
Corporate actions are initiated as a decision by a meeting of the board of directors. Once the decision is made, the information is distributed to each shareholder through appropriate notifications. The shareholder then has to play their part in the corporate action as necessary.
- What is a corporate action notification? – Once the corporate action decision is made by the company, it is notified to the shareholder. The notification can be through various convenient channels, mostly electronic communication. The shareholder has to then take necessary action on their part if necessary.
- How do you track corporate actions? – For listed companies, all the required information will be available with the stock exchanges. The information from there is distributed through various communication channels and agencies. Nowadays it is easy to track the progress of corporate actions through electronic means, including various mobile apps.
An appropriate understanding of the most common corporate actions of a company is essential for anyone dealing with shares and finance. It will help to get a clear idea of the financial health of a company. With the understanding, one can easily evaluate the share value of any entity and the knowledge will positively guide one’s decision to buy or sell its shares.
Hope the above discussion has covered the topic elaborately and simply enough to enlighten anyone who looks for such knowledge. The discussion has covered points such as the concept of corporate actions and types, examples of corporate actions and its impact on share prices and NAV, the process of undertaking a corporate action, the role of a shareholder in a corporate action, etc. and more, with sufficient details.
Also read: Invest in equity to beat inflation?
Also read: Key events and their impact on markets
Also read: What is Reserve Bank of India or RBI?
Also read: What the heck is an index fund?
Also read: How inflation is eating your money!
Also read: What is share market – basics explained
Also read: How many stocks you have in your portfolio?
Also read: You “need” a car but you “want” a BMW
Also read: Being rich and wealthy are not the same