What Is Corporate Action: Meaning, Types & Tax Implications

Introduction:

When scurrying through the stock market to shortlist companies to invest, it is necessary to look into the company’s finances, market trend, and industry performance over the years. While macroeconomic factors also add to the precision of your investment decision, corporate action also plays a vital role in directing your portfolio’s returns, as they affect the value of the company’s shares. How exactly? And what are the corporate actions to examine before investing? Let’s understand. 

What are Corporate Actions?

A corporate action is a decision made by a publicly traded company that directly affects its assets. In simpler terms, it refers to actions that bring about significant changes in the company. These actions are usually approved by the board of directors elected to oversee the company’s operations. In some instances, shareholders also get to vote on these decisions.

Corporate actions impact people connected to the company, including preferred or common shareholders, stakeholders, and bondholders. Some examples of such corporate action include (but are not limited to) changing the company’s name or brand design, entering a merger, acquiring a company or getting acquired, declaring bankruptcy, creating spin-off companies, and declaring a bonus issue. 

Types of Corporate Action:

Mandatory Corporate Action: 

Mandatory corporate actions are decisions a company’s board of directors makes that apply to all shareholders. For example, when a company issues a cash dividend, you don’t need to do anything except collect it. These actions are handled by the company’s governing body, ensuring everything runs smoothly for you. 

Besides dividends, other mandatory actions include spin-offs, stock splits, and mergers. “Mandatory” means you, as a shareholder, don’t have a say in the matter—you automatically participate in whatever corp action the company takes.

Mandatory Corporate Action with Options: 

The board initiates these actions, but shareholders are given options. For example, when a company offers dividends, you can choose between stock shares or cash. Stock shares are usually the default option. If you don’t make a choice, you’ll receive the dividend as shares of the company’s stock. 

This flexibility lets you decide how you want your payout, but the company automatically enforces the mandatory option if no decision is made. It’s a simple way for companies to give you control while having a fallback option.

Voluntary Corporate Action: 

These actions require shareholders’ participation, for example, in a tender offer. Since it’s voluntary, you can decide whether to participate. Each shareholder must submit a response about their participation. If you tender your shares at the set price, you’ll receive a payout from the sale. 

Each corporate action significantly affects shareholders, influencing share value, ownership structure, and taxation. But do all actions create the same impact, or do they affect shareholders differently? Let’s go through the various corporate actions to understand their unique implications.

Common Corporate Actions:

Dividends:

A dividend is a regular income paid to shareholders by a company from its profits or reserves. Companies may distribute dividends when they don’t have suitable investment opportunities, choosing to share profits to maintain shareholder trust.

The board of directors sets dividend payments, often aiming for each payout higher than the previous year. Dividend payouts, such as paid-up capital or retained earnings, reduce a company’s equity. The company can offer dividends in two ways:

• Cash Dividend: Shareholders receive money for each share they own. For example, if you own 100 shares and the company announces a Rs. 100 dividend per share, you’ll get Rs. 10,000.
• Stock Dividend: Shareholders receive additional shares instead of cash. A 10% stock dividend means if you hold 100 shares, you’ll receive 10 more shares.

Cash dividends show the company has strong retained earnings, while stock dividends signal a potential drop in share price but still reflect the company’s stability. Dividends may cause a share price drop, though not always. Dividends must be reported under “income from other sources.” Dividends over Rs. 5,000 from domestic companies have a 10% TDS, while foreign dividends are taxed at 20%.

Stock Splits

A stock or share split is when a company divides its existing shares into equal parts. For instance, if a company with a face value of Rs.10 per share announces a 1:1 stock split, each share gets split into two, valued at Rs.5 each. Companies do this to increase liquidity and make their shares more affordable to smaller investors. Additionally, a stock split can help the company better reflect the actual value of its shares. 

Mergers and Acquisitions:

A merger happens when two or more companies decide to join together to compete better in a larger market. This creates a new company that combines both the companies’ assets and operations. Shareholders from both companies are then offered shares in the new one. 

An acquisition, or takeover, is when one company takes control of another. Investors might feel uneasy about it, especially if it seems hostile. However, it will likely succeed if the employees and investors support the acquisition. In a takeover, the acquiring company may make a tender offer, inviting shareholders to sell their shares at a set price within a specific time. 

This offer usually includes a premium over the current market price to encourage sales. No set number of shares must be sold, and shareholders can accept the terms for part or all of their holdings.

Depending on the synergy created and the merged entity’s value prospect, mergers and takeovers can cause share prices to rise or fall.

Spin-off:

A spin-off happens when a company creates a new, separate firm from part of its business. As a shareholder, you’ll receive shares in the new company based on what you already own—this is automatic, so there’s no need to apply. 

Spin-offs can lead to either positive or negative market reactions. On the positive side, the new company could be set up to unlock its full potential with independent management. On the negative side, the parent company might just be offloading assets. Depending on the reason for the spin-off, the company’s share value experiences a rise or a decline. 

Declaring a Bonus Issue:

A bonus issue is when a company gives additional shares to its shareholders. For example, with a 2:1 bonus issue, if you own 2 shares, you’d get 1 extra share. Companies usually offer bonus shares to manage liquidity. While this can impact the price of shares and earnings per share, it benefits shareholders in the long run as share prices tend to rise. A bonus issue often shows that the company is financially strong, suggesting that the share prices will likely increase over time.

Rights Issue:

A rights issue happens when a company offers extra shares to its current shareholders, not the public. Unlike bonus shares, you need to pay for these shares, but they are usually at a discount. For example, HDFC Bank did a rights issue in October 2018 with a ratio of 1:4. This meant you could buy 1 share for every 4 HDFC shares you held. The shares were priced at Rs 1,000 each, about 15% less than the closing price on the record date.

Companies issue rights shares to raise money for expansion or debt repayment. So, it’s essential to subscribe only if you believe in the company’s future after proper research.

Buyback of Shares:

A share buyback occurs when a company buys its shares from shareholders, often at a higher price than the market value. Companies do this to increase their ownership, gain more control, support the share price, boost earnings per share (since fewer shares will be in circulation), or build trust with investors. Generally, a buyback shows the company’s confidence in its future and often increases the share price. 

Bottomline:

Understanding how corporate actions affect stock prices is prudent in ensuring you go with the market’s flow and maximize your gains. Analysts and stock experts closely examine these actions to determine why prices change and whether those changes are likely to last. If you want to interpret a company’s corporate actions more precisely, it’s always a good idea to consult a registered stock market advisor for better market insights and advice based on your risk profile and investment goals.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

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