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Understanding Corporate Action

05 Dec 2023

The concept of corporate action is important to grasp as this can affect the investment individuals make in the stock market. If you hold shares or are considering purchasing stock in a company, you should know how any action taken by the company will impact the company’s stock. Consequently, the first question you probably need to get an answer to is, “What is corporate action?”. Before you understand the concept of corporate action, you should know that corporate action tells you a lot about the financial health of a company.

Understanding Corporate Action

You may have heard of the terms “stock split” or “dividends”. These are examples of corporate actions. So, what is corporate action? Simply put, it is any action taken by a publicly listed organisation/company which has some effect on the price of the stock of the company in question. Corporate actions are major decisions taken by a company. Typically, they have to be approved by the board of directors of a company as well as be authorised by the company’s shareholders for implementation. 

What is corporate action? How does it help you?

Corporate actions have an associated or direct influence on shareholders as they own shares in the company conducting the actions. Before you invest or after you have invested in any company’s stock, corporate actions act as a gauge to know how financially sound the company is. This helps you in your decision-making when you wish to invest in a stock, or whether you should exit or stick with stocks. The more informed you are about stock investing, the better prepared you are to take financial decisions aligned with your goals. 

Types of Corporate Actions

Once you have understood what corporate action means, you should know the types of corporate actions and how they may affect your investment. The following are the main types of corporate actions you may come across: 

  • Stock Split

The stock split divides the value of every outstanding share of a company. This is also known as a bonus share. The most common form of a stock split is a two-for-one split. So, an investor who holds one company share will now own two shares automatically, with each of the two worth exactly half of the price of the initial share held. What the company announcing the split has done is cut its stock prices in half. In such cases, the market may adjust the share price upwards on the day that the split is implemented. What are the effects of this? Current stockholders are rewarded, while potential ones get interested in the stock. 

  • Dividends

While speaking about types of corporate actions, you may commonly come across dividends. A company will typically issue dividends in cash, but some companies may issue them as stocks too. They are paid to shareholders at certain periods, and these may be quarterly or yearly. Essentially, when a company pays dividends, it is sharing the company’s profits with shareholders. 

When a company pays a cash dividend, the payout is straightforward. The company pays a specific amount of money for each share held. For instance, if an investor has 200 shares and the cash dividend works out to Rs. 0.50 per share, the shareholder will be paid Rs. 100. 

Dividend payments affect the company’s equity. The distributable equity is reduced. A stock dividend also arises out of distributable income. For instance, if a company pays a stock dividend of 10%, the shareholder will receive one share for every ten shares held. 

  • Rights Issues

Knowing what is corporate action and its types gives investors ways to estimate how a company is fundamentally performing. You may have heard the words “rights issue” and wondered what this meant. A company that implements a rights issue is offering new shares or additional shares to current shareholders only. In the event of a rights issue, existing shareholders have the right to buy or receive shares of the company before they are offered to the public. 

  • Mergers & Acquisitions

When two or more companies combine into one company, with all involved parties agreeing to terms and conditions, a merger is said to have occurred. Generally, one firm surrenders its stock to the other firm. When a merger takes place, shareholders may view it as an expansion. In contrast, they could also draw conclusions that the industry may be shrinking, compelling a company to adopt a competitor to keep it going (or growing). 

While understanding the types of corporate actions, knowing about acquisitions is also vital. An acquisition occurs when a company purchases a majority stake in another company’s shares. There is no merging or swapping of shares, and mergers can be hostile or friendly. 

  • Spin-Offs

This occurs when a current public company makes a sale of a portion of its assets or distributes fresh shares to form a new and independent company. This could indicate that a company is prepared to take on a new challenge in terms of growth. 

Corporate Action and Reaction

When you open a demat account to invest in the share market, you would undoubtedly do some thorough research before actually buying stock. You may do the same if you wish to explore an upcoming IPO. Whether you are an existing holder of stock or are about to be one, knowing about corporate action keeps you informed about the companies whose stock you are interested in. 

 

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