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Any action taken by the company that affects its share price and impacts the stakeholders of the company is known as Corporate action.
These decisions are taken by the board of directors and sometimes shareholders are allowed to vote on these events i.e. Corporate actions are authorized or initiated by the board of directors and approved by the shareholders of the company.
Different types of Corporate actions
Corporate actions can be classified as:
- Voluntary corporate actions
- Mandatory corporate actions
- Mandatory with choice corporate actions
What is Voluntary corporate action
A voluntary corporate action is an action where the shareholders elect to participate in the action i.e. it requires a decision whether the shareholder is willing to participate or not.
A response is required for the corporation to move forward with the corporate action.
Types of Voluntary corporate actions
Some examples of voluntary corporate actions are Rights issues and Share buyback.
1. Rights Issue
It is a way by which a company raise capital by issuing fresh and new shares to the existing shareholders of the company. Rights Issue is different from a public issue as here the company issue its shares, not to all of the public but its shareholders.
The shares that are issued during a rights issue are known as right(s) shares.
Only listed companies can come up with rights issues which means the shares of such companies are already listed on the stock exchange. So, a company needs to issue rights shares at a discount to the market value of the shares i.e the issue price of rights shares is lower than the market price of shares.
In a rights issue, shares are issued in a specified ratio i.e. The shareholders can subscribe to the rights issue in the proportion of their shareholding.
For instance, the 1:5 rights issue would mean that for every 5 shares that a shareholder owns, he/she can subscribe to 1 right share. If someone owns 20 shares, he/she can subscribe to 4 right shares.
A share buyback is repurchasing of shares from the shareholders by the company i.e. It is the re-acquisition by a company of its shares.
The share buyback is also known as a Share repurchase.
It is a very flexible way of returning money to the shareholders. The company that repurchases its shares, buy them at a price higher than the market price of the shares. If the company tries to buy back its shares at a price equal to or less than the market price, the shareholders may decline the offer because they can sell their shares to other investors (through the secondary market) whose bids are higher than the company.
There could be many reasons why companies choose to buy back shares:
- To increase the EPS (Earnings per share) as the repurchasing of shares decrease the number of outstanding shares.
- To strengthen their (promoters) stake in the company.
- To show the confidence of the promoters about their company.
- To support the share price from declining.
- To prevent other companies from taking over.
What is Mandatory corporate action?
It is mandatory for shareholders to participate in these corporate actions and hence the name “Mandatory corporate action”.
The word “mandatory” is not appropriate as the shareholders aren’t required to do anything; the shareholder is just a passive beneficiary in all such actions. There is nothing the shareholders have to do in a Mandatory Corporate Action.
Types of Mandatory corporate actions
Some examples are Bonus Issue, Dividends and Stock split.
1. Bonus Issue
It is a way of giving bonus shares to the shareholders by the company. The company has no such intention to raise capital behind the bonus issue. The shares given during the bonus issue are just the free shares.
But this does not mean that the company blindly distributes these shares. Like the Rights Issue, bonus shares are also given in a specified ratio.
For example, a 1:5 ratio here would mean that the shareholders would get 1 free (additional) share for every 5 shares held by them i.e. at no extra cost. If someone has 20 shares, then after the bonus issue he/she will have 24 shares of that company as he/she will get 4 bonus shares on his shareholding.
2. Dividends
A dividend is a way of distributing the profits earned by the company to its shareholders. The company does not distribute its whole profit as a dividend but as a part of it and even it is not that compulsory for a company to give dividends to its shareholders.
The distribution of regular dividends is not mandatory but the distribution of preferred dividends is mandatory. Well, it depends on who will get the regular dividend and who will get the preferred dividend as per the holding of equity and preference shares i.e. if you’re an equity shareholder you’ll receive a regular dividend and if you’re a preference shareholder then you’re entitled to get the preferred dividend.
Dividends are paid in 2 ways: either in cash or in the form of free shares. Thus, we can classify dividends into Cash dividends and Stock dividends.
Cash Dividend
Through Cash dividend, the company gives you free cash as per your shareholding. Well, you also receive cash from the company during the Share buyback but there you give your shares in return.
A cash dividend is the distribution of funds or money paid to shareholders generally as part of the company’s current earnings or accumulated profits.
The cash dividend is always declared by the company on the face value (FV) of a share irrespective of its market value i.e. The rate of dividend is expressed as a percentage of the face value of a share.
For example, 100% dividend which means if the face value of the share is Rs 1 then you will get Rs 1 per share as a dividend (as 100% of 1 is 1).
Stock Dividend
The Stock dividend appears the same as Bonus Issue because in both corporate actions company offers you bonus shares or free shares without any additional cost.
Then, why there are two terms if the context is the same?
Well, there is a slight difference between both.
In a bonus Issue, bonus shares are distributed according to a specified ratio like 1:5 but in the case of a Stock dividend, bonus shares are given by the company in the form of a percentage.
For example, If the company is distributing a 5% stock dividend then it means that the one who owns the 100 shares of that company will get 5 free shares.
As the equity share capital is a part of share capital (and the other part is preference share capital) but whenever we talk about share capital, we refer to the equity share capital. In the same manner whenever one talks about the dividend he/she refers to the cash dividend because among the stock and cash dividend, the latter is more popular and general.
3. Stock split
A stock split can be categorized into 2 types: Forward Stock split and Reverse Stock split.
Forward Stock split
In a forward stock split, the existing shares of the company are divided into multiple shares. The shares are split in a specified ratio like 2:1 or 5:1.
You can see that in the above ratios, the digit before the ratio sign is greater than the digit after the ratio sign and this way of representing the ratio shows us that a stock split is a forward stock split.
The interpretation of the 2:1 ratio is that your 1 share will be split into 2. In the same manner, if you have 20 shares they will split into 40 shares.
Reverse Stock split
Opposite to the forward stock split, in a reverse stock split, the shares get merged in a specified ratio like 1:2 or 1:5.
You can see that in the above ratios, the digit before the ratio sign is smaller than the digit after the ratio sign and this way of representing the ratio shows us that a stock split is a reverse stock split.
The interpretation of the 1:2 ratio is that your 2 shares will merge into 1. Similarly, if you have 40 shares they will be merged into 20 shares.
In the stock market world, when we hear about dividends we interpret them as cash dividends. Similarly, whenever you see the term stock split, do not get confused that, "which stock split is this?" its interpretation is about forward stock split as the stock split tells us that stock is splitting and this occurs in Forward stock split and not in Reverse stock split.
What is ‘Mandatory with choice’ corporate actions
It is a mandatory corporate action where shareholders are given a chance to choose among several options where one of those options is the default. As participating in the corporate action is a choice for the shareholders, they may or may not submit their elections. In case a shareholder does not submit the election, the default option will be applied.
“Optional dividend” is an example of a ‘Mandatory with choice’ corporate action where the shareholder can elect to receive the dividend either in cash or in stock i.e. the company can ask the shareholders whether they want a cash dividend or a stock dividend. . And if the response is nothing from shareholders, the company can distribute the type of dividend that they have decided as a default option. Let’s say, cash dividend.
Corporate actions examples
Well, there are a lot of examples of corporate actions. As the list of decisions taken by the company that can affect the stock price or can impact the stakeholders is endless.
The corporate actions that we’ve discussed in this article along with some other examples are following:
- Rights Issue
- Share Buyback
- Bonus Issue
- Dividend
- Stock split
- Spin-offs
- Mergers and Acquisitions
- Tender Offer
- Changing the company’s name or brand design
- Company’s liquidation
Purpose of Corporate action
The primary reasons companies use corporate actions are:
- To distribute profits to shareholders
In the form of dividends or by repurchasing the shares from the shareholders at a higher price than the market price, the company distributes the profit it made to its shareholders.
- To keep the share price in a range
If the share price is too high or too low, it impacts the stock liquidity. If the share price is too high, retail investors can’t afford it and if it is too low, the stock may be delisted from the stock exchange.
So, to make the shares affordable for the general public, the company announces a forward stock split and such corporate actions that decrease the share price and to make sure the stock doesn’t get delisted, the company increase the share price through a reverse stock split.
- Corporate restructuring
Mergers & Acquisitions and Spin-offs help companies to restructure themselves to increase their profitability.
Conclusion
Corporate actions are the initiatives taken by companies. These initiatives affect the share price of the company. One needs to understand the different types of corporate actions to get a better understanding of the stock market.
Suppose, people are buying a particular stock because its share price has suddenly increased in the last several days but you decide to stay away from this stock because you know that this increase is the result of a reverse stock split.
This is only one example. There can be many.
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