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The term “corporate action” is one of the most important in the world of business and finance. The term has immense relevance and value to anyone, from the CEO of a large corporation to the smallest stockbroker. A corporate action can change the future of a business, for better or for worse. Since this is one of those essential concepts for anyone with little interest in the stock and stock markets to understand, it is a humble attempt to clear it up in simple terms for anyone. Anyone willing to learn. Here we will look at the meaning of corporate actions, their importance and relevance, different types of corporate actions with examples, and their impact on the market stocks, how they are made, and more.
What are the Company’s activities?
A corporate action is generally a transaction initiated by a company and may have significant influence or impact on related parties. They usually follow the decision of the company’s board of directors with the approval of the shareholders. A corporate action can be as small as changing the company’s name with little impact on its financial health. On the other hand, it can also be decisive such as a merger decision or a financial decision such as the distribution of dividends or bonuses to shareholders.
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Depending on the type of action taken by the company, it can change the equity value of the company or stay the same. In general, the majority of a business’ actions will be seen as a reflection of the business’s financial health and well-being. Those who carefully observe the changes and fluctuations that occur in the stock market scenario can easily assess the financial condition of a company and decide whether its stock is reliable not by looking at the actions of the company it initiated.
Why are corporate actions important?
What are the reasons a company initiates such actions? There can be many reasons for a company to take a collective action. Let’s see.
No business organization can operate in isolation from its environment. This means that it is constantly interacting with its environment and must adapt to any changes that occur there. For a company to survive and thrive, it needs to take initiatives in response to a change in its environment.
Even without a sudden change in the environment, a company can still take corporate actions. This can be part of a company’s long-term plans and strategies. Based on strategy, a company can frequently initiate various corporate actions such as annual dividend distribution or based on different business dynamics. Likewise, there can be many other reasons why a company initiates various corporate actions. Even if a company is about to go into liquidation, it will have to use certain corporate actions to complete the legal formalities.
What are the types of corporate actions?
All the small and big corporate actions combined can make up a long list. For convenience, they are often classified into different categories. They can be considered as mandatory and voluntary actions of the company. They can also be classified into actions that have a financial impact on shareholders and those that have no financial impact. There may be corporate actions related to a new entity, such as corporate mergers or acquisitions. However, the actions of the business that are considered most decisive are those that have a financial impact. Here we take a detailed look at what are the types of corporate actions, especially those that have a financial impact.
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Dividends
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. When a company pays you a dividend, they are actually paying you cash equivalent to a portion of the value of the stock you own. This will reduce the value of your stock by that amount. It is important to know the terminology of certain dates in relation to dividends.
- Dividend announcement date: The date the Board of Directors meets and decides to pay dividends.
- Registration Date: On this date, usually about 30 days after the declaration, shareholder records in the company register are checked to pre-select those who are eligible to receive the dividend.
- Ex-dividend Date: Also known as Ex-Exempt Date, it usually falls on two days prior to the book-date, as dividends are issued on a T+2 basis. Ex date conformity is that only shareholders holding shares before this date are considered to receive dividends.
- Dividend Payment Date: This is the date on which actual dividends paid to eligible shareholders are recognized.
Different companies pay dividends at different times of the year and at different times. Based on this, 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
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Bonus Stock
These are additional shares offered by a company to its shareholders. Free 1:1 issue means shareholders receive one more share for each share they already own. Generally, when a company has liquidity problems or cannot pay dividends, it issues free stock from its profits or reserves.
But there is no such thing as a free meal. In the case of a free allocation, the company’s share price decreases in proportion to the proportion of free shares issued. So in a 1:1 bonus issue, the share price will drop by 50%. Other metrics, such as earnings per share (EPS), will also fall. However, over the long term, and when stock prices rise, investors tend to profit. There is no tax on the free stock allocation. Bonus issues are often an indicator of a company’s good health and suggest that its profits will grow over the next 2 to 3 years.
When the value of shares declines with a bonus issue, the company often becomes accessible to small investors. Furthermore, since the company’s issued equity profile looks attractive, it has a better profile. However, its reserves face certain depletion. The action does not require an election because the total share capital does not change.
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Merger
What is merger corporate action? Sometimes two companies may merge to become a new entity. The resulting company is called a merger. This is a company action that is different from actions such as issuing dividends or bonuses. It transforms the entire profile of the companies involved.
This way, the best of both companies can be used to the company’s advantage. This leads to the benefits of better economies of scale, opportunities for diversification, greater market share, increased sales, and more.
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Buybacks
Buyback is the process by which a company buys back some of its own shares from shareholders. This can be a sign that the company has healthy cash reserves. The acquisition is made by a public tender offer to shareholders. There can be a number of reasons why a company makes a takeover. Acquisitions can lead to one of the following outcomes:
- Consolidation of shares of the company
- Prevent stock prices in the market from falling too low
- Creates demand for the stock in the market thereby increasing its price
- Prevent other stakeholders from taking control of the business
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Rights Issue
An issue of rights concerns the issue of additional shares to existing shareholders. This is usually done to generate more capital. While this is similar to issuing new shares through an IPO (initial public offering), in this case the shares are not issued to the public. It is only offered to existing shareholders. If the rights issue ratio is 1:5, that means you are eligible to buy 5 shares for every share you own.
Unlike all of the corporate actions, the rights issue requires shareholders to pay to buy more shares. Because trading takes place directly between the company and individual shareholders, new shares are often priced relatively below the market price. Rights issues can be an indication of a company’s prosperity and stability, as it is confident enough to generate new capital to expand its business into new areas.
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Stock Split
This is a corporate action similar to a bonus and often confuses some investors between the two. However, it has subtle differences. Stock Split is nothing but dividing existing stock into elements. When the par value of a stock remains very high, a stock split is beneficial because it can make the share price more affordable to more investors.
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What are the company’s mandatory and voluntary actions?
- Mandatory corporate actions – These are corporate actions in which shareholders are required to participate. Shareholders have no option to stay away from these corporate actions. Cash dividend, bonus issue, stock split, merger, etc. are all examples of mandatory corporate actions. “Compulsory action with choice” is a transaction that provides certain options to shareholders in the settlement of required action.
- Corporate voluntary action – Unlike mandatory corporate actions, voluntary corporate actions are those that shareholders are free to participate in or ignore. For example rights issue, share buyback, delisted company, etc. Shareholders have no obligation to participate in such actions if they do not wish to.
A proper understanding of the most common corporate actions is essential for anyone dealing in stocks and finance. This will help you have a clear idea of the financial health of a company. With this understanding, one can easily assess the stock value of any entity and the knowledge will positively guide their decision to buy or sell shares.
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