Share prices of a company are affected by numerous external and internal factors including company announcements like dividends, corporate results, etc. These actions can have a positive or negative impact on the share prices, however, some corporate decisions affect the entire shareholder base as well. These are corporate actions and have a lasting effect on the company's share prices and shareholder base. So what exactly are corporate actions and why are such decisions taken? Check out this blog to learn about corporate actions and how they impact the company share prices.
Corporate actions are decisions taken by the management or the board of directors of a company that have an effect on its shareholders and the overall business operations. These actions can be mandatory (where shareholders have no choice but to comply) or voluntary (where shareholders have a choice to comply). Corporate actions are company policies or directions taken by the company that reshape the shareholder base as well as impact the share prices positively or negatively, thereby affecting the company valuations and investor sentiments. Companies taking corporate actions have to adhere to the rules and regulations laid down by SEBI and the Companies Act 2013 to ensure transparency, compliance and protection of investors’ interests at large.
Corporate actions are essential for a company’s growth, stability, and long-term success. They help companies manage their finances, reward shareholders, and improve their market position. Here are a few reasons that can lead to corporate action.
Companies make profits, and corporate actions like dividends and bonus shares help share these profits with investors. When a company gives dividends, it distributes part of its earnings to shareholders as a reward for their investment. Bonus shares, on the other hand, give investors additional shares for free, increasing their total holdings. These actions build trust among investors and encourage them to stay invested in the company.
Companies sometimes need to change their structure to improve efficiency or survive financial difficulties. Corporate actions like mergers and acquisitions help businesses combine their strengths, enter new markets, and compete better. A struggling company can sell some of its divisions, restructure its debt, or merge with another company to remain profitable through a synergy of resources.
Businesses constantly need money to sustain, expand, invest in new projects, and manage debts. Corporate actions like rights issues help companies raise funds by offering more shares to existing shareholders at a discounted price. Similarly, companies can also raise funds through a follow-on public offering (FPO) where a company can issue additional shares to the public to generate more capital at relatively lower costs and compliances as compared to IPOs.
Corporate actions also help maintain a healthy stock market by improving liquidity, investor confidence, and regulatory compliance. Corporate actions like stock splits make shares more affordable for small investors by reducing the price per share. On the other hand, share buybacks boost investor trust by reducing the number of available shares, which can increase the stock price and earnings per share (EPS). Furthermore, issues like ensuring transparency and legal compliance may lead to corporate actions like the delisting of the company to adhere to SEBI regulations. Overall, these measures help businesses stay competitive while ensuring the protection of investor interests and the stability of the stock markets as a whole.
There are various examples of corporate actions taken by a company to meet its corporate needs. However, they can be broadly classified under two main categories, i.e., mandatory and voluntary corporate actions. The key difference between the two is the presence of choice shareholders get to participate in such corporate actions or not. These categories of corporate actions are explained hereunder.
Mandatory corporate actions are decisions taken by the company that apply to all shareholders, whether they agree or not. Such actions do not require any action from shareholders, and the required process is carried out by the company automatically as per the rules and regulations prescribed by SEBI, the Companies Act 2013, and related relevant laws. Shareholders have no control or say over such corporate actions. These actions are usually taken to benefit the company and its investors and are essential for the company’s growth and financial management. Examples of mandatory corporate actions include dividends, stock splits, bonus shares, mergers and acquisitions and delisting.
Voluntary corporate actions give shareholders the choice to participate or not. Unlike mandatory actions, shareholders must respond to the company’s offer if they want to take part. These actions allow investors to make decisions based on their financial goals. Voluntary corporate actions give investors the flexibility to make decisions based on their interests, which can impact their investment returns. Examples of voluntary corporate actions include share buybacks, rights issues, FPO and tender offers.
Corporate actions influence a company’s financial position and directly affect share prices. Some actions may increase investor confidence and push stock prices higher, while others may temporarily lower prices due to dilution or other factors. Here are some common examples of corporate actions and their impact on share prices.
Dividends are a portion of the company profits that are distributed to the shareholders as a reward and can be distributed as interim dividends and final dividends or a one-time dividend during a financial year. Companies Act 2013 has prescribed detailed guidelines and requirements for the issue of dividends and the funds to be used for the same to ensure transparency and avoid any window-dressing effects. Dividends can be paid from distributable reserves and surplus of the company in the form of cash (fixed price per share) or in the form of stock dividends (extra shares instead of cash). Companies that make consistent profits and have a consistent dividend policy are seen as good investment options by investors with both short-term and long-term perspectives.
Share prices often rise before the dividend payment because investors expect a reward.
Share price usually drops by the dividend amount on the ex-dividend date (when new buyers are not eligible for dividends) since that value has been paid out.
While high dividends can indicate a strong company, very high payouts may also mean the company has limited vision for long-term or future growth.
Bonus shares are additional shares given to existing shareholders for free. This action is also a way of distributing profits to the shareholders, however, instead of cash dividends, additional shares are given to the shareholders. These shares are distributed in a fixed ratio based on the number of shares already held by shareholders. For example, a 1:2 bonus issue means an investor gets 1 extra share for every 2 shares they own. Bonus shares lead to an increase in the total number of shares in the market but do not change the company’s total value.
The share price reduces in proportion to the bonus issue since more shares exist, but the investor's total value remains the same.
Lower-priced shares may attract more buyers, increasing trading volume and liquidity.
Investors see bonus shares as a sign of a company’s confidence in its future performance.
A rights issue allows existing shareholders to buy additional shares at a discounted price before they are offered to the public. This is usually done by a company with a good market presence and investor confidence that requires extra funds for expansion, debt repayment, or other financial needs.
The share price may drop because more shares are issued, leading to dilution (existing shares lose value since the total number of shares increases).
If investors see the rights issue as a positive move for the company’s growth, the stock price may recover over time.
A stock split reduces the price of each share by increasing the number of shares in circulation. For example, a 2:1 split means every 1 existing share is split into 2 shares, and a 5:1 split means every share turns into 5. The total value of the company remains the same in a stock split, but each share becomes more affordable.
The share price decreases in proportion to the split, making it more affordable for small investors.
There is a potential increase in the number of investors after the stock split due to its better affordability, leading to increased demand and liquidity.
The eventual increase or rise in stock prices after a split due to higher market participation.
A share buyback happens when a company repurchases its own shares from the market to reduce liquidity and uses its surplus reserves to create a relatively smaller shareholder base instead of distributing dividends. This reduces the number of shares available, which can improve earnings per share (EPS) and increase the value of the remaining shares.
The share price often rises as share buyback reduces supply, making each remaining share more valuable.
Investors see a buyback as a sign that the company is confident about its future, boosting market sentiment.
However, if the company spends too much on buybacks instead of growth, it could lead to long-term financial issues.
A merger occurs when two companies combine to form a new one, while an acquisition occurs when one company takes over another. Both are strategic corporate actions taken to improve business efficiency, enter new markets, or gain competitive advantages.
If the merger or acquisition is seen as beneficial, the stock price of the acquiring company may rise, while the stock price of the target company may jump to match the purchase price.
If the market sees risks or debt from the deal, the acquiring company’s stock price may fall.
Uncertainty during mergers may cause temporary volatility in stock prices.
A demerger happens when a company splits a part of its business into a separate company. This is done to improve focus and efficiency or unlock value for shareholders. The newly formed company operates independently but may still be linked to the parent company. A demerger can happen in different ways, such as spinning off a division or selling a part of the business.
After a demerger, the parent company’s share price may initially fall since part of its business is separated.
However, if investors see growth potential in both companies, the combined value of the two stocks may increase over time.
The newly formed company may experience volatility as investors assess its future performance.
A successful demerger often helps both companies grow independently, leading to long-term stock price appreciation.
This is the last stage for a company when its shares are removed from the stock exchanges, either voluntarily (company decision) or involuntarily (due to regulatory issues or poor performance). The delisting of the company leads to restrictions in the trading of the company shares from the stock exchanges.
Share prices may rise before delisting if investors expect a high exit price from the company.
After delisting, the company's liquidity disappears, and investors must sell shares in the over-the-counter (OTC) market, often at a lower price.
Forced delisting due to non-compliance damages investor confidence and causes sharp price drops.
Corporate actions play a crucial role in a company’s growth, financial stability, and investor relations. These are important decisions made by the companies that impact their shareholders and stock prices. While some corporate actions increase share prices, others may cause temporary declines. Understanding corporate actions helps investors make smart decisions and take advantage of market opportunities in the stock market.
This article is another step in understanding the basic concepts of a company and its fundamental analysis. Let us know your thoughts on this topic or if you need further information, and we will address it.
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Read More: How do you do a fundamental stock market analysis?
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
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