10 Must-Know Corporate Actions for Investors

Corporate actions are typically decisions made by a company’s board of directors, and these decisions can have a significant impact on both the company itself and the people who own shares in it. Let’s dive deeper into this topic and explore its implications.

The Context

Similar to how the stock market is affected by regulatory activities taken by governing agencies like SEBI in India or the SEC in the United States, a company’s stock also has a normal lifespan that is largely determined by corporate actions.

The corporate finance Institute (CFA) defines corporate action as “any action taken by a company“.

To clarify, it is a decision that typically the board of directors makes that has a significant effect on the business and its shareholders. These actions are broadly classified as mandatory and voluntary.

A mandatory corporate action is an event initiated by the board of directors of the corporation that affects all shareholders. Unlike mandatory corporate actions, voluntary corporate actions are actions where the shareholders elect to participate.

A response is required for the corporation to process the action. This list outlines 10 hand-picked corporate actions to help you provide some sharp references and understanding of what precisely a stock goes through when action announcements are made.

This knowledge will enable you to increase your stock market expertise whether you are a novice investor or an experienced trader.

1. Stock Splits

Owning the shares of a company that increases in value over time is every stock investor’s ultimate dream. A stock split is often a sign that a company is thriving and that its stock price has increased.

While that’s a good thing, it also means the stock has become less affordable for investors. As a result, companies may do a stock split to make the stock more affordable to pocket and tempting for individual investors.

A stock split is a situation in which the number of shares outstanding by a company is increased by breaking already listed shares into smaller denominations. A stock split simply increases the total number of shares while lowering the price of each share without changing the market capitalization, or total value, of the shares held.

If the company management believes the shares of its firm are undervalued, it can signal this to potential investors by performing a stock split. For example, If company X announces a split of 2-for-1 (Or 2:1), each investor will own double the number of shares, and each share will be worth half as much while their total value remains the same.

Meaning, that a person holding 50 shares will now have 100 shares with each share valued at half the previous denomination. The splits automatically get adjusted in the Demat account and hence no action is required from the Shareholder.

2. Reverse Splits

A reverse stock split or reverse split is a process by which shares of corporate stock are effectively merged to form a smaller number of proportionally more valuable shares. A reverse stock split is also called a stock merge.

There are different motives for executing this corporate action. Some key reasons are –

💬 Minimum price requirements imposed by exchanges to avoid de-listing.

💬 Improve the share price as any share costing less than ₹10 in India and costing less than $5 in the US are considered penny stocks.

Cheap stocks do not qualify for the investment-grade criteria.

💬 If a company decides to spin off its business, it may do a reverse stock split to maintain its company’s share price post-spinoff.

A reverse stock split itself doesn’t impact an investor as their overall investment value remains the same, even as stocks are consolidated at a higher price. But the reasons behind the reverse stock split are worth investigating. The split itself has the potential to drive stock prices and investor sentiments down.

3. Dividend Payout

A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it can pay a proportion of the profit as a dividend to shareholders. Any amount not distributed as dividends is taken to be re-invested in the business.

Typical characteristics of companies that consistently pay dividends are “Value” stocks. A dividend payout is an action executed to incentivize shareholders for the continued holding of company stocks. This makes the company more attractive to investors, which helps to drive the stock price higher.

The dividend is always declared by the company on the face value (FV) of a share irrespective of its market value. The face value of stocks or shares is the price of the stock as stated by the company. What you see on the stock tickers is called the Market value. The rate of dividend is expressed as a percentage of the face value of a share per annum.

For example, if a company with a face value of ₹1 and a share price of ₹100 announces a dividend of 100% of the face value, it means a dividend of ₹2 per share.

Click here to read the special article on the top ten Indian dividend stocks.

4. Mergers & Acquisitions

Mergers and acquisitions, or M&A for short, involve the process of combining two companies into one. The goal of combining two or more businesses is to try and achieve synergy – where the whole (new company) is greater than the sum of its parts (the former two separate entities).

Mergers occur when two companies join forces.

Such transactions typically happen between two businesses that are about the same size and which recognize advantages the other offers in terms of increasing sales, efficiencies, and capabilities. The terms of the merger are often fairly friendly and mutually agreed to and the two companies become equal partners in the new venture.

Acquisitions occur when one company buys another company and folds it into its operations. Sometimes the purchase is friendly and sometimes it is hostile, depending on whether the company being acquired believes it is better off as an operating unit of a larger venture.

Mergers are considered favorable for investors as it eliminates competition and adds to the Shareholder value. The acquisition is altogether a different game.

The acquisition can affect the stock prices of both companies involved. Multiple studies suggest that the Stock prices of merged companies (the target) tend to spike during an acquisition. The stock price of a company that is acquiring the target however tends to dip temporarily as they pay a cost and usually a premium to purchase the firm.

Surprisingly, a large number of Indian retail investors think the contrary.

5. Rights Issue

A rights issue is a corporate action where existing shareholders are allowed to buy a set number of new shares in the company they own. These new shares are often available at a discount to the existing share price. This is done to encourage investors to participate.

The money raised from the rights issue can be used in many ways. It could be the acquisition of a rival, investment in a new product, or even paying down debts.

The discounted price offered to the shareholders is also known as the ‘rights offer price’.

6. Spin-Offs

A corporate spin-off is a corporate action where the parent company splits off part of itself (such as one of its divisions) into a separate business. Spin-offs are only done if the company thinks that a unit of their enterprise has grown into an independent business and is thus lucrative as a stand-alone entity.

When a spinoff happens, investors in the parent company automatically become investors in the subsidiary through the distribution of new shares. The new shares are thus automatically credited to the shareholder Demat account.

However, the price of the original shares is proportionally split based on the newly formed entity’s market capitalization.

7. Bonus Issues

Bonus issues are shares distributed by a company to its current shareholders as fully paid shares free of charge. The money for creating “BONUS” issues often comes from the dividends that have been accumulating over time but were not distributed among shareholders.

A bonus issue is assumed as a good sign and shows a company’s allegiance to shareholders and long-term growth. A company earns its right to issue bonus shares when they have earned massive profit or has accumulated large free reserves that cannot be utilized for any particular purpose and can be distributed as dividends.

Companies issue bonus shares to encourage retail participation and increase their equity base. However, these bonus shares are given to the shareholders according to their existing stake in the company.

For instance, if an investor owns 100 shares of a corporation and the company announces a 2:1 bonus, he will receive 2 additional shares for free for every share he owns. His overall stake will rise to 300 shares after receiving a total of 200 shares for free.

Even if the word “BONUS” seems appealing in this context, acquiring bonus shares has little in the way of advantages or disadvantages from the perspective of an investor. The bonus issues only increase outstanding shares and thus boost the liquidity of a stock.

What you must also know about receiving bonus shares is that your profits will remain the same as rolling out bonuses leads to a fall in earnings per share (EPS). The fact that bonus shares are tax-free when you receive them is the only benefit of their issuing.

8. Tender Offer Buyback

A tender offer is a public bid for stockholders to sell their stock back to the company. Companies usually offer a tender bid to regain a larger equity interest in the company. This also serves as a way to offer additional returns to shareholders as a premium is offered over the market price.

A tender offer is usually seen in late-stage startup companies that have floated out private equity (unlisted stocks) during their formation years. For publicly traded stocks, a tender offer follows a similar process.

The company makes an offer to buy back stocks from its shareholders (Offer price) at which the shareholders can tender their shares. A tender offer is considered good for retail investors. Being a delicate process, the two risks associated with a tender offer are the failure or delay in execution and the acceptance ratio. A failure or a delay can happen because of slips in the norms and protocols specified by the governing bodies (SEBI/SEC).

Similarly, the acceptance ratio depends upon the buyback size and the quantity tendered in the buyback. It’s a random selection process very similar to IPO allotments.

According to news announcements, investors typically stock up on a particular company’s shares, and in the event of a failure, delay, or approval rejection, they are left with their inventory for a long time.

9. Market Buyback

Market Buy-Back is a corporate action in which a company buys back its shares from the open market. This is different from tender offer buyback where the transaction is executed by brokers of the company itself at prevailing market prices.

Since a large quantity of shares is purchased back, the buyback process continues for a long period. The main reasons driving an open market buyback are company consolidation, equity value increase, and/or a way to look more financially attractive.

The share prices usually increase in the long run because buyback reduces outstanding shares in the market. A retail investor should be aware of the single drawback, which is that occasionally this is financed with debt, which might impact the company’s cash flow.

10. Delisting

This is typically the last phase of the lifecycle of a listed or publically traded stock. The stocks that get delisted may still exist on over-the-counter markets held by company promoters or institutions.

Once the stock is delisted its price can no longer be determined through trading on a particular market. The key reasons to de-list a stock as a result of corporate action may result from failing to meet requirements of an exchange, bankruptcy, near-bankruptcy, and also by means of voluntary delisting.

In case of voluntary delisting, the shareholders receive a bidding form along with the official letter to surrender their stocks. A company usually goes for the latter when it decides on a complete structural overhaul.

Selling a de-listed stock is difficult as it ceases to trade on the stock exchange. You can however sell them on the over-the-counter market by finding a buyer outside the stock exchange. It is by Indian law mandatory for the listed organizations to make a minimum of 25 percent of their shares available for trading to the general public.

If the promoters decide to hold more than 25 percent of float at any given point then the company is subjected to mandatory de-listing.

Conclusion

One of the core components of investing is understanding company behavior. The stock prices are significantly affected by each activity or corporate action in this regard.

All corporate actions serve to develop the best investing strategy because they are reflections of a company’s character and business practices. That concludes our top 10 list of corporate actions that can affect an investor’s approach.

Please feel free to remark if you believe that we have overlooked any important activity that ought to be mentioned here.

🔔 Investing is expensive, but leaving comments on this blog is free!

Invest wisely!