Any event or decision by the management of public-listed companies that have the potential to influence the securities issued by the company – equity or debt – qualifies as corporate action. Because of the potential impact on investments or holdings of investors, corporate action remains one of the keenly watched spaces among investors. This article delves into the concept of corporate actions and describes the types of corporate actions and what to watch for as investors.
This article covers:
What is a corporate action?
Any action by a public-listed company that causes a significant change or has the potential to create a change in the securities issued by the company and influences its stakeholders is called a corporate action.
When a publicly-listed business takes corporate action, it starts a process that impacts the price of securities it has issued. Corporate activities can range from severe financial issues like bankruptcy and dissolution to changing the title or trade symbol, etc.
Corporate activities include dividends, spin-offs, stock splits, mergers and acquisitions as well as management changes. A firm’s proxy statement, issued before a public company’s annual meeting, will generally include corporate actions requiring shareholder approval.
How does it work?
Publicly listed firms are usually governed by a board of directors, which comprises individuals intimately associated with the company and are appointed to various roles.
Any corporate action must be approved by the board of directors, which is usually done by a vote. In certain circumstances, shareholders are given the option to vote on some or all of the company’s corporate actions. Corporate activities, on the other hand, influence the stakeholders, direct and indirect.
Types of corporate actions
The following are the three fundamental categories of corporate actions:
The board of directors of a corporation is responsible for enacting mandatory corporate activities. The issue of a cash dividend, for example, is a necessary activity that affects all of the company’s owners. The company’s governing body carries out the action. Other required acts include spin-offs, stock splits, and mergers. In this sense, “mandatory” indicates that stockholders have no option but to accept the action made.
Mandatory (with several options)
Mandatory corporate actions with alternatives provide shareholders with a variety of choices. For example, take dividends issued by a company. The firm can give dividends in the form of stock or cash, with the latter being the default choice. But here, the shareholders have the option of selecting a dividend payment method.
Voluntary corporate actions are activities in which shareholders choose to take part. A tender offer or rights issue is an excellent example of voluntary corporate action.
Examples of corporate actions
1. Stock split and reverse stock split
A company may decide to go for a stock split or reverse stock split. A stock split is a situation in which a corporation declares that the face value of its shares will stand divided. The stock’s market price may decline due to this practice, while the company’s market capitalisation remains unchanged. A reverse stock split, alternatively, has the opposite effect. It is used as a tactic for raising share price by decreasing the number of outstanding shares.
2. Bonus issue
These are free shares that the company’s shareholders get in exchange for the shares they hold. The reserves in shareholder funds are used to issue bonus shares. Companies announce the ratio by which new shares are distributed to existing stockholders. The number of shares issued rises when bonus shares are given, but the overall value of the shares remains the same.
3. Merger and acquisition
A merger happens when two or more ventures agree to join to expand their operations and profits. Similarly, an acquisition occurs when a more prominent firm buys or overtakes a smaller company.
Corporate spin-offs happen when a company, for reasons of expanding or new acquisitions, ‘spins-off or ‘separates’ a part of its company to create a parallel venture.
Mandatory action with several options
Most financially sound firms pay their shareholders a part of their profits in the form of dividends. This is however not a compulsion for the firm. The company may choose to reinvest the profit to further growth. When it is issued, shareholders have a choice to select either cash dividends or stock dividends. If the shareholders don’t submit their preference within the prescribed time, then the default option is applied – which is cash dividends.
A firm might offer to buy back its shares from current stockholders if it believes the price is too low or has excess money that it cannot put to good use. Buybacks lower the number of shares in circulation, resulting in higher EPS.
2. Rights issue
A firm does this by issuing new shares to all current stockholders in proportion to their stake in the company. Often, new shares are given at a discount to encourage shareholders to apply in the offering. For example, in a 3:1 rights issue, a stockholder can purchase one share for every three shares he holds in the firm.
Corporate action is any action performed by a corporation, usually by its board of directors, that substantially impacts the firm and its shareholders. Changing a company’s name/brand, mergers, acquisitions, spin-offs, and dividends are all examples of corporate activities. Corporate actions can fall into either category: mandatory, mandatory with options and voluntary actions. To profit from corporate actions, investors need to keep an eye on all the updates happening in the financial world.
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