A corporate action occurs when a company does something that affects its share capital or its bonds. For example, most companies pay dividends to their shareholders twice a year. Corporate actions can be classified into two types.
Mandatory Corporate Action
A mandatory corporate action is mandated by the company, not requiring any intervention from the shareholders or bondholders. The most obvious example of a mandatory corporate action is the dividend payment since all shareholders automatically receive the dividend.
Voluntary Corporate Action
A voluntary corporate action is an action that requires the shareholder to make a decision. An example is a takeover bid – each shareholder must choose whether to accept the offer if the company is being bid for.
Securities Ratios
Before we look at various corporate action types, it is necessary to know how the terms of a corporate action, such as a rights issue or bonus issue, are expressed – a securities ratio.
When a corporate action is announced, the terms of the event will specify what will happen. This could be as simple as the dividend amount paid per share. For other events, the terms will announce how many new shares the holder is entitled to receive for each existing share they hold.
For example, a company may announce a bonus issue whereby it gives new shares to its investors in proportion to the shares it already holds. The terms of the bonus issue may be expressed as 1:2, which means that the investor will receive one new share for each existing two shares held. This is the standard approach used in many capital markets where an investor will receive ‘X new shares for each Y existing shares’ or just ‘X for Y.’
Rights Issues
A company may wish to raise additional finance by issuing new shares. This might be to provide expansion funds, repay bank loans, or bond finance. In such circumstances, it is common for a company to approach its existing shareholders with a ‘cash call’ – they have already bought some shares in the company, so would they like to buy some more?
A rights issue can be defined as an offer of new shares to existing shareholders pro rata to their initial holdings. Since it is an offer and the shareholders have a choice. In a rights issue, shareholders can buy additional shares at a specified price, usually at a discount to the current market price.
These rights are usually tradable – that is, the investor can sell their right to subscribe for new shares as they have a value because the holder can subscribe at a discount to the current market price.
Example: Rights Issue
ABC ltd has 100 million shares in issue, currently trading at Rs 40/- each. It offers its existing shareholders the right to buy one new share for every five previously held to raise finance for expansion. This would be described as a one-for-five rights issue. The price of the rights would be set at a discount to the prevailing market price example;
- Take up the rights – by paying the Rs 30/- per share and increasing their holding in ABC ltd to six shares.
- Sell the rights to another investor – the rights entitlement is transferable (often described as renounceable) and will have value because it enables the purchase of a share at the discounted price of Rs 30/- per share.
- Do nothing, i.e., if the investor chooses this option, the company would sell the rights at the best available price and pass on the proceeds (after charges) to the shareholder.
The share price of the investor’s existing shares will also adjust to reflect the additional shares being issued. So, if an investor originally had five shares priced at Rs 40/-each worth Rs 200/- and can acquire one new share at Rs 30/-, on taking up the rights, the investor will have six shares worth Rs 230/-or Rs 38.34/-each. The share price will, therefore, change to reflect the effect of the rights issue.
Impact of Rights Issue on Existing Share Price
The initial response to the announcement of a rights issue may be for the share price to fall until the market has time to reflect on the reasons for the problems and view what that means for the prospects of the company. If it is to finance expansion, and the strategy makes sense to the investors, then the share price could subsequently recover. However, if the money is to be used for a plan that the market does not think highly of or to manage operational issues, the response might be the opposite.
The company and its advisers must consider the numbers carefully. If the price at which new shares are offered is too high, the cash call might flop. This would be embarrassing and potentially costly for any institution that has underwritten the issue.
Open Offer
An open offer could be seen as a variation on the rights issue when a company wants to raise finance.
An open offer is made to existing shareholders and allows the holders to subscribe for additional shares in the company or other securities, generally in proportion to their holdings. This is similar to a rights issue, but the difference is that the right to buy the offered securities is not transferable and cannot be sold.
For an average open offer, holders of the shares cannot apply for more than their entitlement. However, an open offer can be structured so holders can use it for more than their pro rata entitlement, with the possibility of being scaled back if the offer is oversubscribed.
Bonus Issue
A bonus issue is a corporate action when the company gives existing shareholders extra shares without having to pay any amount for these additional shares.
In a bonus issue, the company increases the number of shares held by each shareholder and capitalizes its earnings by transferring them to shareholders’ funds.
Example: Bonus Issue
A company announced a bonus issue after its Board of Directors meeting. The directors recommended approving the capitalization of Rs 10 Million out of the revenue reserves of the company. The sum is to be distributed as 1 Million bonus shares among the holders of ordinary shares, in the proportion of one new common share of Rs 10/-each for every 20 ordinary shares then held.
A bonus share issue is an offer of free additional shares by a listed company, given to existing shareholders in proportion to their holdings in the listed company.
The reason for making a bonus issue is to increase the liquidity of the company’s shares in the market and to bring about a lower share price. The logic is that if a company’s share price becomes too high, it may be unattractive to investors.
Stock Split and Reverse Stock Split
An alternative to a bonus issue to reduce a share price is to have a subdivision or stock split whereby each share is split into many shares.
For example, a company with shares having a book value of Rs 50/- each and a market price of Rs 100/- each may have a split whereby each share is divided into five shares, each with a book value of Rs 10/-each. In theory, the market price of each new share should be Rs 20/- each (Rs 100 ÷ 5).
There is little difference between a bonus issue and a stock split; a stock split alters the book value of a share, and a bonus issue does not change its book value.
A reverse split or consolidation is the opposite of a split in which shares are combined or consolidated. For example, a company with a share price of Rs 10 may consolidate ten shares into one. The market price of each new share should then be Rs 100 (Rs 10*10). A company may do this if the share price has fallen to a low level and they wish to make their shares more marketable.
Dividends
Dividends for many large companies are paid twice a year, with the first dividend being declared by the directors and paid approximately halfway through the year (commonly referred to as the interim dividend). The second dividend is paid after approval by shareholders at the company’s annual general meeting (AGM), held after the end of the financial year, and is referred to as the final dividend for the year.
Many large companies now pay dividends more frequently, say paying them quarterly, with the first three being interim dividends followed by a further final dividend.
The amount paid per share may vary, as it depends on factors such as the overall profitability of the company and any plans it might have for future expansion. Dividends are sometimes paid as shares instead of, or in combination with, cash and are often called a ‘Stock Dividend.’
The individual shareholders will receive the dividends by cheque or the money transferred straight into their bank accounts.
A practical difficulty, especially in a large company where shares change hands frequently, is determining who is the correct person to receive dividends. There are, therefore, procedures to minimize the extent that people receive dividends they are not entitled or fail to receive the dividend to which they are entitled.
Shares are bought and sold with the right to receive the next declared dividend up to the date when the declaration is made. Up to that point, the shares are described as cum-dividend. If the shares are purchased cum-dividend, the purchaser will receive the declared dividend. The shares go ex-dividend between the declaration and the dividend payment date. Buyers of shares are not entitled to the declared dividend when they are ex-dividends.
The standard settlement period is T+2. This means that a trade is settled two business days after it is executed, so, for example, a trade executed on Monday would settle on the following Wednesday.
Example: Dividend
The sequence of events for a company listed on an exchange like NSE might be as follows: ABC Co. calculates its interim profits (for the six months to September 30th) and decides to pay a dividend of Rs 5/-per share. It announces (i.e., declares) the dividend in October. It states that it will be due to those shareholders who are entered on the shareholders’ register on November 1st, i.e., the ‘Record Date.’ The dividend payment will then be made to those shareholders at a later specified date.
This Record Date might also be known as the:
- Register Date
- Books Closed Date.
Given the record date of Friday, November 1st, as the Record Date, the NSE sets the ex-dividend date as Thursday, October 31st. (Assuming both the days, i.e., November 1st and October 31st, are working days)
On the ex-dividend date, the shares will go ex-dividend and should fall in price by Rs 5/-. As a result, new buyers of ABC Co. shares will not be entitled to dividends.
Takeovers and Mergers
Companies seeking to expand can grow organically or by buying other companies. In a takeover, which may be friendly or hostile, one company (the predator) aims to acquire another company (the target).
In a successful takeover, the predator company will buy more than 50% of the target company’s shares. When the predator holds more than half of the target company’s shares, the predator is described as having gained control of the target company. Usually, the predator company will look to buy all of the shares in the target company, perhaps for cash, but generally using its shares or a mixture of cash and shares.
A merger is a similar transaction when the two companies are of similar size and agree to merge their interests. However, in a merger, it is usual for one company to exchange new shares for the shares of the other. As a result, the two companies effectively merge to form a more significant entity.
Company Meetings
Public companies must hold annual general meetings (AGMs) at which shareholders can question the directors about the company’s strategy and operations.
The shareholders are also allowed to vote on matters such as the appointment and removal of directors and the payment of the final dividend recommended by the directors.
Most matters put to the shareholders are ordinary resolutions, requiring a simple majority (more than 50%) of those shareholders voting to be passed. However, issues of significant importance, such as a proposed change to the company’s constitution, require a special resolution requiring a more substantial number of shareholders to vote in favor, generally at least 75% of those voting.
Shareholders can either vote in person or have their vote registered at the meeting by completing a proxy voting form, enabling someone else to register their vote on their behalf.