What is Corporate Action?

April 26, 2023

What is Corporate Action? How does it affect the Stock Market?

Corporate Action refers to any action taken by a publicly listed firm that impacts its brand name, stockholders, or stocks.

Read the article to understand everything in detail.

Imagine you own a beauty parlor that is very popular in your neighborhood. 

Due to your services, your parlor owns a distinctive identity in your locality and even amongst clients who live in distant places. 

Suppose, you happen to replace your staff, change the name of your parlor, or change the offers you were offering to your customers. 

Will it not impact your parlor or your existing clients? 

It surely will. 

Corporate Action is something similar to this. 

A corporate action is an event carried out by a company (usually by its management). It has a substantial impact on the company and its shareholders.

Continue reading the blog to learn more about Corporate Actions and how they affect share prices. 

Content:

Corporate Action Meaning

When a publicly-traded company issues any action that affects its brand name, shareholders, and stocks, it is called Corporate Action. These actions will help you know a lot about the company’s financial health and determine whether to buy or sell a specific stock of the company.   

Whenever companies plan to come up with any corporate action, it instantly affects the price of their stocks.

The only objective of companies to carry out corporate actions is to increase their profitability and create better opportunities for their shareholders.  

Now that we know what a corporate action is let us discuss the types of corporate actions that significantly impact stock prices. 

Types of Corporate Actions

There are three main types of Corporate Actions: 

  1. Mandatory 
  2. Mandatory with Choices
  3. Voluntary 
  1. Mandatory: 

Mandatory corporate actions are enacted by the Board of Directors to bring significant changes to the company.

The objective is to improve from the previous year’s performance. 

In Mandatory corporate actions, the shareholders don’t have much to do. They simply have to follow whatever the management decides.  

The mandatory corporate actions are – 

  • Dividends 
  • Spin-Offs
  • Stock Splits 
  • Mergers and Acquisitions
  • Dividends

A dividend is a payment made by publicly traded companies to their shareholders from their surplus earnings. They distribute their profit to the shareholders at the end of the financial year.

Not only profit, even if companies incur a loss in a particular year, some companies still give off dividends in the form of cash, shares, and currency equivalents if they have a healthy cash reserve. 

The decision to pay dividends lies in the hands of the management. The company directors meet at the Annual General Meeting (AGM) to decide whether or not to pay a dividend.

Note: A company can also choose not to pay dividends every year if their policy doesn’t state so! 

So, dividends can also fall under the category of Mandatory with Choices Corporate Action. 

Usually, there is a formula based on which dividends are paid out to the shareholders. 

The formula is – Dividend Payout Ratio = Dividends Paid / Reported Net Income.

The dividend payout ratio can quickly decide how much money a company will offer to its shareholders. Furthermore, the ratio can be used to calculate the amount of money that is reinvested to build and develop a company’s operations, pay off existing loans, or build a cash reserve.

So, you see, paying dividends is the best way to hook the shareholders with the company.  

To know about the highest dividend paying stocks, tap this link to read the article. 

  • Spin-Offs

Spin-off corporate action is an operational strategy where a company creates a secondary entity from its parent company. 

In exchange for a certain amount, the new company acquires assets, employees, or existing product lines and technologies from the parent company. 

The new company that is formed from the parent company is expected to be more valuable. Once the separate entity is created, it is introduced to the market with a new brand name. 

  • Stock Splits

Stock Split is a corporate action where a company issues a certain number of shares to its existing shareholders. The splitting is done by dividing one share into more shares. 

To know more about Stock Split, read our blog on Stock Split.

Assume Priya owns 200 shares of a company at₹10 each, and the company announces a stock split of 1:2. Now Priya’s 200 shares will be split into 2 parts, i.e 400 shares and the price of each share will be ₹ 5 after the split.

The calculation will be somewhat like this –

Before the stock split ₹10X200 Shares = ₹2000,

After the stock split, the price of each share will become ₹5, so the market price of the shares will be ₹5X400 Shares = ₹2000.

Though the number of shares increases, the overall value of the investment remains the same.

The stocks can be split at the ratio of 1:4, 1:2, and 1:10 (depending on the requirements). 

When the stock price rises beyond the standard level and shareholders become uncomfortable with the rising price, the stocks are split. This increases the liquidity of the stocks. 

Similar Read: What Is Face Value Of A Share?

  • Mergers and Acquisitions

When two companies believe that joining hands together can make them more successful and survive in the bigger market, they merge. A new entity is formed with the assets and operations of both companies.

Whatever shares both the companies had separately before the merge will be given to the new entity after the companies have become one single unit. 

On the other hand, when a company completely takes over the assets and liabilities of another company, it is called an Acquisition. 

  1. Mandatory with Choices:

These are corporate actions where the management gives several options to the shareholders to choose from. 

Out of the several options, one will be a default option. 

Before the company takes any action, the shareholders vote on it. They might also choose not to vote. 

If they don’t vote, the default option will be considered, and the shareholders will have to follow that. 

Let’s take the example of dividends. A company can offer dividends in the form of stocks or cash dividends. Out of these, one can be the default option. 

Let’s say the stocks are the default option. 

So, if the shareholders haven’t voiced their particular choice, they have to accept the stocks as dividends.   

  1. Voluntary:

In the voluntary corporate action types, the shareholders tend to be a part of the decision-making process. 

This means the shareholders need to participate in certain decisions to ensure the smooth functioning of the company. 

But, before making any decision, each shareholder has to submit their opinion stating if they want to participate or not. 

Just like in a tender offer, a shareholder ‘might’ buy all the shares of the company. It’s their choice.

You must be wondering, what is a tender offer? 

Typically, when an investor proposes to buy shares from every shareholder of a publicly-traded company for a specific price at a specific time, this is known as a tender offer. The investor offers a higher price per share than the company’s stock price, giving shareholders more incentive to sell their shares.

This is a pure example of voluntary corporate action. 

How do Corporate Actions Affect the Share Prices?

In the previous section of the blog, we have already stated that corporate actions significantly impact stock prices. 

Corporate actions portray the intention of the company towards its shareholders. 

The reputation and recognition of the company depend on the type of corporate actions the company carries out.

Other than dividends, stock splits, and mergers & acquisitions, there are other examples where corporate actions significantly impact stock prices. 

They are – 

  • Bonus Shares

This is a corporate action where a company gives off shares to its existing shareholders free of cost. The primary reason for giving out bonus shares is to improve a company’s brand recognition and to reward its shareholders. 

The bonus shares are usually given off in the form of 2:1, 3:1, 5:1, etc.

For example, if you own 100 shares of a company worth ₹10 and the company announces bonus shares at a 3:1 ratio, this means for one share the company will give you 3 more shares free of cost. 

After this, you must be wondering when the bonus shares will be distributed.

To be eligible for a Bonus Share, you need to buy the shares at least one day before the ex-date. Bonus shares are not available to people who join the company after the ex-date.

If you are eligible for Bonus shares, it usually takes 15 days from the record date for the shares to be credited to your Demat account.

  •  Rights Issue

When companies want to increase its share capital by offering shares at a discounted price to its shareholders, then Rights issue is implemented. 
It is an invitation to current shareholders to purchase additional shares in the company, but the shareholders needn’t necessarily participate in the rights issue. They will only subscribe to this rights issue if they are convinced of the company’s future success.

The stock price of the company issuing rights shares is adjusted just after the record date, which is a cut-off date set by the company.

Shareholders have the option of subscribing to the rights issue in part or in full, or they can even decline the offer of purchasing additional shares. Not only this, but they can also transfer their rights to other people. 

The process of transferring rights issues to other people is called the “Renunciation of Rights Issue.”

  • Buyback of Shares

This is an action where a company circulates its shares within itself. 

In simple words, it is a method where a company invests in itself by buying shares from its investors. 

This helps the company to 

  1. Restore confidence in itself
  2. Prevent other companies to acquire it
  3. Improve the profitability of each share.

Corporate Action Life Cycle

In the Corporate Action Life Cycle, we are going to see the entire process of the Corporate Action performed by the Corporate Action setup team.  We will learn about the crucial players or participants involved to carry out a specific Corporate Action and what are the roles of each participant in the entire process. 

  1. The first player is the one who announces the corporate event to the market. 
  1. The second player is the registrar and the custodian who is in the processing stage for the preparation of the event. 

Mind you, the registrar is a very important player in a company who communicates with the custodian, and the custodian further communicates with the brokers. 

The custodian then further informs the investment banks regarding the decided corporate event. They give intricate details of the event, like – the tax benefits, the positions, and holdings of stocks, their entitlement rights, settlement dates, etc. 

  1. Then comes the role of the team in itself. That is, the Corporate Actions Processing Team will validate the happening of the event by sending messages across. 
  1. And the last step is the payment. On the pay date, the entitlements will be credited to the accounts of the shareholders. 

We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:

Market What is Primary Market?
Difference between IPO and FPO
Bull vs Bear Market
Trading What is Online Trading?
What is Algo Trading?
Investment What is Bonus Share?
What is Valuation of Shares?
Analysis Stock Market Analysis
Individual Topics Stock Market Analysis
India Vix
Difference between FDI and FII
Account What is Trading Account
What is Demat Account

Quick Summary

  • When a publicly-traded company issues any action that affects its brand name, shareholders, and stocks, it is called Corporate Action. The main objective of companies to carry out corporate actions is to increase their profitability and create better opportunities for their shareholders.
  • There are three main types of Corporate Actions: 
    • Mandatory – This type of corporate action is enacted by the management to bring significant changes to the company. The objective is to improve from the previous year’s performance. 
    • Mandatory with Choices – These are corporate actions where the management gives several options to the shareholders to choose from. Out of the several options, one will be a default. 
    • Voluntary – In this type of corporate action, the shareholders need to participate in certain decisions to ensure the smooth functioning of the company. 
  • Corporate actions portray the intention of the company towards its shareholders. The reputation and recognition of the company depend on the type of corporate actions the company carries out.
  • The factors that impact stock prices are: Dividends, Spin-Offs, Stock Splits, Mergers and Acquisitions, Bonus Shares, Rights Issues, and Buyback of Shares.
  • The Corporate Action Life Cycle is the entire process of the corporate action carried out by the processing team. The life cycle ranges from the announcement of the event to the entitlements getting credited to the shareholders’ account. 

FAQ

1. Where can I find out about any corporate action announced by a company?

When companies plan to issue any corporate action, they tend to give off press releases or use social media platforms to convey the message. 

You can also find the information on the BSE Corporate Actions Website andNSE Corporate Actions Website

2. Can I check the Corporate Announcements on the Alice Blue website?

No, we don’t have that option yet. But we are working on it. 

3. What are ex-date and record date in corporate action?

Ex-Date – To be eligible for a bonus share, you need to buy the shares at least one day before the ex-date.  Bonus shares are not available to anyone who joins the company after the ex-date.

Record Date –  The Record Date is the deadline set by the company to meet the criteria for bonus shares. The company will issue bonus shares to all shareholders who have shares in their Demat Account on the record date.

Leave a Reply

Your email address will not be published.

Blog Categories
Kick start your Trading and Investment Journey Today!
Related Posts
Previous
Next