What are corporate actions and why you need to be aware of them?

Corporate actions are activities that material effect an organisation and impacts the key stakeholders including shareholders and creditors. They can affect the stock price both in good and bad ways. Corporate actions are most often determined and voted on by the board of directors of the company. Although sometimes, shareholder will be given the chance to either vote or participate in these actions such as placements.

Why are they important?

Corporate actions materially affect the share price are highly important to understand. This means that the actual value of the company or the share price will change due to one of these actions. This also means that they can be great catalysts for volatile trade opportunities

Examples of Common Corporate Actions

Dividends

Mature companies or companies who record consistent profits may issue dividends to their ordinary shareholders. It is important to understand what a dividend is. It is a company distributing a share of its profits to give back to investors. This dividend is paid to investors and means that once the dividend has been returned the share price must be adjusted to reflect the reduction in future cashflow. Dividends may also be issued via a reissuing of shares or a reinvestment plan.

Stock Split

A stock split is when a company decides to split each of its shares by a certain ratio for example 1:5 or 1:10. The reason that companies will split stocks are usually for liquidity purposes. When a company has small number of outstanding shares it often leads to low liquidity and volatile prices due to large spreads between the bid and ask prices. Therefore, by splitting stocks the company can improve the liquidity of its share price. The results of this action will increase liquidity but also lower the share price and volatility of the security.

Reverse stock split or consolidation

The process of a stock consolidation is just the reverse of a stock split. This occurs when a company’s share price is too low or is too easily manipulated because there are too many shares available to trade. It is also important to note that most exchanges have rules that will strike out company’s trading on their exchange if the share price drops too low. Therefore, a stock consolidation may occur may have to happen out of necessity.

Mergers and Acquisitions

Mergers and acquisitions are probably the most complex corporate action to understand. They generally involve one company buying or taking over another company. This process can take some time and is not as generic as the other actions. There are multiple ways in which the buying company can purchase the other company. It may involve payment of cash, debt, shares, option, or a combination of these and other financing options. Most often the company buying, will have to pay a premium to cover the goodwill from the company being acquired. The initial bid therefore provides a valuation for the company being acquired. To further complicate matters, a bid especially an initial bid is not always the final offer which makes finding a fair value for the share price difficult and provides great opportunities for trading as the market tries to find the fair value.

Rights Issuing or share placements

Companies for a variety of reasons need to raise money. They can do this by selling new shares to existing shareholders or even private institutions. This enables the company to increase its equity. At the same time this dilutes the shares outstanding which will most likely reduce the price of the company’s shares. In addition, these placements or new issues are often prices that are already discounted to the price at the time of the placement. A company may raise capital for a variety of reasons which include, increasing cash at hand, dealing with liquidity problems, purchasing of new equipment, purchasing of another company.

Share Buyback

A share buyback is when a company decides to purchase its own shares from the float to reduce the number available for trade. Companies may do this to either regain control of some of the shares or also to increase the value of their shares for its holders. Whilst it is a different mechanism it has a similar effect to a dividend. This is because as the company buys back the shares the supply reduces, and the purchasing of the shares increases the market price.

Corporate actions are an important part of the capital markets and as catalysts for price changes for shares. Therefore, traders should be aware of the different types of corporate actions and the effect they can have on the price of a company’s share price.