Corporate Actions - Meaning and Types

If you’re planning to invest in a company for the long term, you need to know what corporate actions are and the different types of actions a company may take during its lifetime. This will help you make well-informed investment decisions. 

In fact, even if you’re investing for the short term, being aware of the various corporate actions can help you time your entries and exit more accurately. Here’s an in-depth look at the meaning of corporate actions and the different types. 

What are Corporate Actions? 

Publicly listed companies occasionally take certain actions that may impact their shareholders significantly. These actions are termed corporate actions and are approved by either the company’s Board of Directors, shareholders, or both. 

Depending on the nature and type of corporate action, the company’s stock price, ownership structure or financial position may get affected. In some cases, all three aspects may undergo a significant change. 

What are the Different Types of Corporate Actions?

Now that you’ve seen the meaning of corporate actions, let’s look at the different types. There are as many as 8 major types of corporate actions a publicly listed company may take. 

Cash Dividends

The distribution of cash dividends is one of the most common types of corporate actions. Companies that make profits consistently tend to distribute them to their shareholders as a reward for investing in them. This distribution of profits is known as cash dividends. 

Cash dividends are calculated as a percentage of the face value of the shares. For instance, if the face value of a company’s shares is Rs. 2 per share and it declares a cash dividend of 200% of its face value, its shareholders would get Rs. 4 as a cash dividend for every share they own. 

Bonus Issue

A company need not always distribute dividends in cash. Sometimes, they may also choose to distribute their profits by issuing bonus shares. Bonus shares are additional shares issued to a company’s shareholders for free. 

These bonus shares are issued in proportion to the current holdings. For example, a company may declare a bonus issue at a 2:1 ratio. This means that for every 2 shares a shareholder owns, they would get 1 bonus share for free.  

Stock Splits

Another one of the more common types of corporate actions is a stock split. In a stock split, a company increases the number of its outstanding shares by proportionally reducing the face value and the stock price. 

Here’s an example. A company with 10 lakh shares at a face value of Rs. 10 each decides to split its stock in the ratio of 2:1. This corporate action will double the number of shares held by a shareholder, but will halve the face value of each share from Rs. 10 to Rs. 5. Such a move will also halve the stock price and increase the number of outstanding shares of the company to 20 lakh shares. 

Share Buyback

A share buyback is a relatively uncommon corporate action. In a stock buyback, a company purchases its shares back from its shareholders, reducing the number of outstanding shares. A company may purchase its shares from the secondary market (through stock exchanges) or reach out to its shareholders with a special buyback offer. 

The reduction in the number of outstanding shares due to a share buyback not only increases the ownership stake of existing shareholders but also increases the amount of control they have over the company. 

Rights Issues

A rights issue is one of the many ways to raise additional capital. In a rights issue, a company gives its current shareholders the right to purchase additional shares at a discounted price compared to its current market price. A shareholder may choose to exercise the right offered to him by the company or trade the right to another interested investor in exchange for cash. 

Mergers and Acquisitions

In a merger, two or more individual companies combine to form a new entity. Here, the shareholders of the merged companies are offered shares in the new entity in proportion to their holdings. 

In an acquisition, one company completely buys out another company. The shareholders of the acquired entity are compensated with shares of the company that acquired it in proportion to their holdings. These types of corporate actions affect the stock prices of both the acquiring and target companies.

Spin-Offs or Demergers

A spin-off or a demerger involves creating a new independent company by separating a division or a subsidiary from the parent company. In this case, the parent company’s shareholders receive shares of the newly demerged company for free in proportion to their holdings in the parent company. 

Tender Offers

A tender offer is an open offer invitation to all the shareholders inviting them to sell their shares back to the company at a specified price and within a specified time frame. Depending on the nature of the tender offer, the company may either choose to purchase some or all of the shares of its shareholders. 

Conclusion

As you can see, each type of corporate action has different implications for both shareholders and the company. While some merely alter the company’s capital structure, others impact the financial position of both parties involved. Since these corporate actions have significant implications, as an investor, you should always be on the lookout for announcements made by a company.