What Are Corporate Actions and How Do They Affect Investors?

Corporate actions are financial decisions taken by a company that can directly impact its future and the share price. These actions are approved by the board of directors and may result in changes to the company’s structure, ownership, or distribution of profits to shareholders. Dividends and Stock splits are some of the corporate actions examples.

Corporate actions are important for investors as they can influence share value and overall investment returns. This blog explains what corporate actions are, why companies announce them, and how common actions such as stock splits, mergers, dividends, and rights issues affect investors.

What are Corporate Actions?

Corporate actions are financial decisions taken by publicly listed companies that can lead to changes in stock prices. These actions are approved by the company’s board of directors and may result in significant changes that directly affect company stakeholders, including shareholders.

Types of Corporate Actions

There are three major types of corporate actions:

1. Mandatory Corporate Action

Mandatory corporate actions are initiated by the company’s board of directors and apply to all shareholders. Participation in these actions is compulsory, and shareholders do not have the option to decline. Common examples include stock splits, mergers, bonus issues and spin-offs.

2. Voluntary Corporate Action

Voluntary corporate actions allow shareholders to decide whether or not to participate. Shareholders must submit a response to the company indicating their choice within the specified timeframe. Examples include rights issues, share buybacks, and early redemption of bond issues.

3. Mandatory Corporate Actions with Choice

Under this type of corporate action, participation is mandatory, but shareholders are given options to choose from. Shareholders may submit their selection based on their preference, or a default option may apply if no response is provided. A common example is the declaration of dividends in the form of cash or stock.

Important Corporate Actions

Below are some of the important corporate actions that investors should be aware of:

1. Stock Split

A stock split is dividing the existing shares to increase the number of shares in circulation. The total value of the investment remains the same. For example, in a 2: 1 stock split, a shareholder receives two additional shares for every one share already owned.

2. Reverse Stock Split

A reverse stock split is undertaken by a company to increase its share price. It reduces the number of shares held by investors by merging the existing ones, this results in an increase in the price per share. This action is often used to consolidate shares and improve the company’s market perception.

3. Dividends

Dividends are payments made by a company to its shareholders from its post-tax profits. They can be issued in the form of cash or additional shares and are usually paid quarterly or annually. Dividend payments reduce the company’s distributable equity. A regular cash dividend often indicates strong financial health.

4. Rights Issue

A rights issue is used by a company to raise additional capital. Instead of approaching new investors, the company offers new shares to its existing shareholders first, usually at a discounted price. This gives current shareholders the priority to invest before the shares are offered to the public.

5. Mergers and Acquisitions

A merger occurs when two or more companies combine to form a single entity based on mutually agreed terms. An acquisition occurs when one company purchases a controlling stake in another company. Acquisitions can be friendly or hostile, depending on whether the target company agrees to the purchase.

6. Understanding Stock BuyBacks

A stock buyback occurs when a company repurchases its own shares from the market. This reduces the number of shares outstanding and can increase the value of remaining shares. A buyback often signals the company’s confidence in its future performance.

7. Spin-off

A spin-off occurs when a company separates a part of its business into a new, independent company. Shares of the new company are usually offered to existing shareholders before being made available to new investors.

8. Bonus Shares

Bonus shares are additional shares given by the company to existing shareholders when they are not in a position to pay a dividend to its shareholders. If a company declares bonus shares in the ratio of 3:1, this means shareholders will get 3 shares for every 1 share held.

Impact of Corporate Action on Investors

Corporate actions directly affect shareholders in several ways, as outlined below:

1. Income Generation

Dividends serve as a source of passive income for shareholders and can provide a regular cash flow. Retirees and long-term investors, in particular, may rely on dividend income from high dividend-paying stocks to meet their financial needs.

2. Effect on Share Price Movement

Corporate actions often influence stock prices in the short term. Positive announcements such as dividends, bonus issues, or share buybacks may create upward price momentum. In contrast, actions such as rights issues or unfavourable mergers may lead to price volatility. Investor sentiment plays an important role in these movements.

3. Investment Opportunities

Certain corporate actions, such as rights issues and stock splits, offer shareholders opportunities to increase their investment in the company under favourable terms.

4. Change in Ownership Structure

Share buybacks can increase an investor’s ownership percentage by reducing the number of outstanding shares. On the other hand, rights issues may dilute ownership if shareholders choose not to participate. Mergers and acquisitions can also result in changes to control and decision-making authority within the company.

5. Decision Making

Shareholders are required to make informed decisions during voluntary corporate actions, such as tender offers, or mandatory actions with choice, such as rights issues. These decisions can have a direct impact on their investment portfolio and long-term returns.

Conclusion

Corporate actions in stock market are decisions taken by the companies that can affect their share prices. These actions play an important role in how much investors earn and how their ownership changes. They also show the company’s financial position and future plans.

Each corporate action affects investors in a different way. Dividends give regular income. Stock splits make shares easier to trade. Actions like mergers, acquisitions and right issues can change ownership and impact investor confidence.

When investors understand what corporate actions are, they can better judge how these actions affect their portfolio and future returns. This helps them make better decisions and build a strong investment portfolio.