Corporate Actions – Types and Purpose of Corporate Actions

Have you ever thought, “Why does the stock price rise or fall when financial results are declared?” This is because financial reports are important financial updates that give the market a  view of how the stocks would perform in the near future. 
  • Stock prices tend to rise when results exceed market expectations.
  • Stock prices tend to fall when results do not meet market expectations.  
In the previous article, we had discussed the various types of corporate actions. Today let us explore what is the purpose of corporate actions and how they affect the share prices.  Purpose of Corporate Actions Bonus, Dividend and Stock Spilt

Purpose of Corporate Actions:

1. Bonus Issue

A bonus issue is an offer given to existing shareholders to subscribe for additional shares of the company. For example, ABC Ltd. has decided to issue bonus shares in 10:1 ratio i.e. for every ten shares, shareholders will get 1 bonus share.  Purpose of Corporate Action - ‘Bonus Shares’
  • The purpose of bonus shares is to encourage and increase the participation of retail investors as the share price decreases considerably in proportion to the bonus shares allotted. 
  • Due to the increase in the number of outstanding shares, the liquidity also increases. 
  • Bonus issue does not involve cash inflow and does not increase the net assets of the company. It only increases the capital base of the company.

2. Stock Split and Reverse Split

Stock splits and reverse stock splits are corporate actions in which a company divides its existing shares into multiple shares.  Purpose of Corporate Action - ‘Stock Split and Reverse Split’ Purpose of Stock Split: Companies choose to split their shares so they can lower the price of their stock to make it affordable for small retail investors and increase the liquidity of the shares. Purpose of Reverse Split: Reverse split is done to raise the price of the share. Through reverse stock split, companies can avoid being categorised as penny stocks and maintain their reputation.

3. Mergers and Acquisition

A merger is the combination of two companies to form one company. Whereas, in an acquisition, one company takes over the other company. Purpose of Corporate Action - ‘Merger and Acquisition’
  • Growth: Merger and Acquisition allows the acquiring company to grow the market share without doing the significant heavy lifting.
  • Eliminate Competition: Merger and Acquisition eliminate future competition. 
  • Synergies: By merger and acquisitions, the overall performance efficiency tends to increase. 
The best example of a merger is Vodafone and Idea, which took place in April 2018.

4. Spinoffs

Spinoff refers to the dissolution of a subsidiary business entity from its parent company to form a new smaller independent organization. Purpose of Corporate Action- ‘Spinoffs’
  • If a company wants to sell a specific segment of the business, it might spin it off to sell it separately and keep the remaining segments intact.
  • Another possibility of a spinoff is if one segment of a company is underperforming spinning it off can increase the value and potential of the parent company by getting rid of a weak spot.
  • On the other hand, If one segment is outperforming it may prove beneficial to the parent company to declare it as a separate legal entity.
  • One of the prominent examples of a spinoff is the e-commerce is eBay Inc had spun off its money transfer business entity, Paypal in the year 2014.

5. Dividend payout

A dividend payout is when the company shares its profit with the shareholders. It can be in the form of cash or stock, which is issued at a specified interval of time i.e. quarterly, semi-annually or yearly. Purpose of Corporate Action - ‘Dividend Payout’
  • Companies who pay consistent dividends are considered to be most stable. However, a decrease or increase in dividend distributions can affect the share price of the company.
  • If the announced dividend is lower than expected, it can cause a fall in the share prices. 
  • If the announced dividend is higher than expected, it can increase the share prices. 

6. Rights Issue

Rights issue is an invitation to existing shareholders to purchase additional new shares at a discounted rate than the stock market.  Purpose of Corporate Action - ‘Rights Issue’ The purpose of a rights issue is to raise additional capital without increasing its debt-to-equity ratio. 

7. Share Buyback

A share buyback is when a company buys back its own shares from its shareholders.  Purpose of Corporate Action - ‘Share Buyback’
  • Companies can announce share buybacks to distribute surplus cash, which will otherwise sit idly with the company. 
  • When companies feel that the shares are undervalued, a share buyback is used to pump up the share price, which acts like support or a new price base for the share.

Key takeaways on the purpose of corporate actions:

  • Corporate actions have a major impact on share prices.
  • The purpose of dividends is to reward the company’s shareholders. 
  • A bonus issue is an offer given to existing shareholders to subscribe for additional shares of the company.
  • In stock split, companies choose to split their shares so they can lower the price of their stock to make it affordable for small retail investors and increase the liquidity of the shares and vice versa for reverse split.
  • The purpose of rights issue is to raise additional capital from existing shareholders. 
  • The purpose of a share buyback is to distribute surplus cash and convey to the shareholders that the promoters are optimistic of the company’s future prospects.

Concluding thoughts: 

As the shareholder of a company, it is essential to have knowledge about the purpose of corporate actions and how it affects the share price.  Participating in these corporate actions through traditional brokers is a cumbersome process as it involves tons of paperwork. But with a Samco Demat account, you can participate in these corporate actions without any paperwork.  So, open the best Demat account in India with Samco in just 5 minutes with Zero paperwork and start investing in the best stocks for long-term wealth creation.

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