If you want to become a successful investor or trader, you should have a thorough understanding of the market fundamentals. An important fundamental aspect of investing is understanding the various types of corporate actions. Corporate actions are decisions that a company makes that affect the stock prices, either positively or negatively.
Some corporate actions might trigger a positive market response while others might affect the share price negatively.
Understanding the types of corporate actions and their purpose will not only allow you to gauge the financial health of the company but will also help you make better financial decisions.
In this article:
- What are corporate actions?
- What are the types of corporate actions?
- Mandatory Corporate Action
- Mandatory with Choice Corporate Action
- Voluntary Corporate Action
- Purpose of corporate actions
- What are some most common types of corporate actions?
What are corporate actions?
Corporate action implies action at management level which has a significant impact on the stakeholders and the financial structure of the company.
What are the different types of corporate actions?
The three basic types of corporate actions are:
1. Mandatory Corporate Action
A mandatory corporate action is decided by the company’s board of directors and it affects all shareholders once implemented. There is nothing much a shareholder can do when it comes to mandatory corporate actions. Some examples of mandatory corporate actions include stock splits, mergers, bonus issues, and spinoffs, etc.
2. Mandatory with Choice Corporate Action.
In ‘mandatory corporate action with choice’, shareholders are given an alternative to choose among several options. For example, they can choose to either get a cash dividend or stock dividend. If case shareholders don’t submit their preference in the given time then the default option is applied.
3. Voluntary Corporate Action
In a voluntary corporate action, the shareholders are given the option to elect or participate in the action. A tender buyback offer is an example of voluntary corporate action.
The Purpose of corporate actions
The two primary reasons for corporate actions are:
1. Corporate Restructuring: Corporate actions such as spinoffs, mergers and acquisition etc take place when a company wants to restructure its business to increase profitability.
2. Impacting Share Price: The liquidity of the stock is greatly impacted if the stock price is too high or low. If the stock price is too high, it becomes unaffordable for small investors. On the other hand, if the stock price is too low, it may be looked upon as a penny stock.
In such situations corporate actions like Stock Splits, Reverse Stock Split or Buyback are used to influence the stock price.
What are the most common types of corporate actions?
Let us take a look at the most common types of corporate action.
1. Mandatory corporate actions
- Bonus Issue
Bonus shares are additional shares given to the shareholders without any extra cost based on their existing shares. When bonus shares are issued, the number of shares increases but the value of the total shares remains unchanged.
- Stock Split and Reverse Stock Split
In Stock Split, the existing shares of a company are divided into multiple shares.
Example: A company has 1000 shares of Rs 100 per share (1000*100=1,00,000). The company decides to split the share for 2:1. Now, the number of shares increases from 1000 to 2000 but the share price reduces from Rs 100 to Rs 50.
So, the overall value of the portfolio remains same i.e. Rs 1,00,000.
The main motive of a stock split is to increase the stock’s liquidity and make it affordable for small investors. A recent example of stock split is the 10:2 stock split of Apollo Tubes.
However, the opposite happens in case of a reverse stock split. In reverse stock split, the number of outstanding shares is reduced to increase the share price. This is done to increase the reputation and liquidity of the stock.
- Mergers and Acquisition
In a Merger two or more companies agree to merge themselves in order to increase the scale of operation and profit.
Similarly, an acquisition is an event where the bigger company acquires a smaller company for further expansion.
Spinoff leads to the creation of an independent company through the distribution of new shares of an existing business. In simple words, it’s a type of divestment.
2. Mandatory with Choice Corporate Action
- Dividend Payout
Dividend is a mechanism through which the company shares the profit with its shareholders. A dividend 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.
[Suggested Reading: Best Dividend Paying Stocks in India]
3. Voluntary Corporate Actions
- Right Issue
The right issue is an offering of subscription rights given to existing shareholders to buy additional securities in a company before it is offered to the general public.
A Right Issue is usually in the form of a Stock Split and the existing shareholders are being given an opportunity to take the first advantage of the new development in the company.
- Share Buyback
A Share Buyback is when companies buy back their own shares from the existing shareholders at an attractive rate.
A share buyback is done with the intention to reduce the shareholder’s stake and also to lower the outstanding shares in the company.
[Suggested reading: Share buyback 2020: Basics of Share Buyback]
Summary of Different Types of Corporate Actions:
|Types of Corporate Actions||Examples of Corporate Actions|
|Mandatory corporate actions||Bonus Issue
Mergers and Acquisition
|Mandatory with Choice Corporate Action||Dividend payout|
|Voluntary Corporate Actions||Right Issue|
As an investor and shareholder, it is very essential to have an in-depth understanding of the different types of corporate actions and how it affects you. This will help you decide the type of corporate action to partici[ate in.
All types of corporate actions have an impact on the stock price and helps investors understand the mindset of the management.
You can participate in all these corporate actions online, without the hassles of physical paperwork, by opening the best Demat account in India with Samco and investing in the best stocks for long-term wealth creation.