Corporate actions are the decisions taken by the board of directors of a company about its activities. A corporate action brings material change to an organisation, affects the securities-equity or bond of that company and impacts its stakeholders.
Corporate actions can be classified into three broad categories:
1) Mandatory: It is initiated by the board of directors to conduct regular affairs of the company.
2) Voluntary: It is initiated by the board of directors but requires shareholders’ approval to move forward.
3) Mandatory with a choice: Here, shareholders are given a chance to choose among several options.
Examples of a few popular corporate actions include:
1) Bonus Issue/Stock Split 2) Reverse Stock Split 3) Merger & Acquisitions 4) Spin-Offs 5) Dividends 6) Right Issues 7) Buy Backs
Purpose of Corporate Actions
Corporate actions are carried for two primary reasons:
1. Corporate Restructuring: A company carries corporate actions such as spin-offs, mergers and acquisitions etc., when it wants to restructure its businesses, subsidiaries and joint ventures due to the policy changes or improve its growth prospects.
2. Impacting Share Price: Stock Splits, Reverse Stock Splits, and Buybacks are all examples of corporate actions that have a significant impact on stock values. These activities are usually carried to improve liquidity, attract larger investors or provide exit, or increase shareholding in the company as per the requirement.
Here is a brief introduction of the most common type of corporate actions:
1) Bonus Issue/Stock Split
Bonus shares are issued to existing shareholders without any extra cost. The ratio of bonus shares is determined based on their existing shares. When a shareholder receives bonus shares, the number of shares increases, but its total value remains unchanged.
This process is usually followed to increase liquidity and encourage higher investor participation. Thereby, increase trading volume.
2) Reverse Stock Split
As the name suggests, in a reverse stock split, a reverse process is followed. In a reverse stock split, the number of outstanding shares is reduced. It will increase the stock prices, but the total value of shareholding will remain unchanged.
With this process, the company controls the flow of liquidity and thereby keeps a check on the kind of investors it wants to get associated with.
3) Mergers and Acquisition
A merger is a process where two or more companies become one entity. Reasons could be to kill competition, improve their visibility, achieve operational synergy and improve profitability.
An acquisition is more hostile in nature where a bigger company acquires the operations of a smaller entity for further expansion. The smaller company ceases to exist, and its operations are taken over by a bigger company.
Spin-off leads to the creation of an independent entity either in the form of a subsidy or a separate entity. New shares are issued in the name of the new entity. The company can choose to hold a controlling stake in it or run as a completely independent entity.
5) Dividend Payout
A dividend is a mechanism to share profits with shareholders. Dividend can be in the form of cash or stock, which is issued at a specified interval of time i.e. quarterly, semi-annually or yearly.
Dividend-paying companies carry the reputation of being financially strong. Often, management uses dividend payout as a measure of ethical practice and is seen as a sign of their confidence in the company’s prospects.
6) Right Issue
When a company issues additional securities (usually shares), it offers the right issue to existing shareholders. Under this, existing shareholders get first rights to buy additional securities before it is offered to the general public.
7) Share Buyback
A company uses a buyback option to buy their own shares from the existing shareholders. A buyback is usually seen as a positive event. Often, a company opts for a buyback by offering a higher price than the existing price quoted in the market. With that, the company creates value for its shareholders.
A buyback is also a signal from the company to the market that it is being undervalued currently. And is often used to lift the sentiments around the stock. When a company buys its own stocks, it showcases the management’s confidence in the company’s prospects.
Apart from these popular corporate actions, any other decision taken by the board of directors can be classified as corporate action. They create a long or short-term impact on a company’s business, its finances or its shareholders.
Hence, if you are an existing investor, it is an absolute must for an investor to understand these concepts and their consequences.