Understanding Corporate Actions

corporate actionsWhen we buy shares over the long run, we hope to not only make capital gains but earn dividends from our investments too.

The act of paying out profits to shareholders is a type of corporate action that affects the securities (equity or debt) issued by the company.

Corporate action events are an integral feature of today’s capital markets and they take place from time to time. By understanding these different types of corporate actions, we can utilise the knowledge to in re-assessing the stock and the subsequent follow-up action to takes, if any.

Corporate actions are typically agreed upon by a company’s board of directors and authorised by shareholders. Some examples are stock splits, dividends, mergers and acquisitions, rights issues and spin-offs.

At the time of writing, SinoGrandness (SGX: T4B) has just undergone a two-for-one share split and Maxi-Cash (SGX: 5UF) has wrapped up its one-for-10 bonus issue.

Here are three reasons for corporate actions:

  1. Return profits to shareholders: Most companies have a dividend pay-out policy to reward shareholders for owning the shares. Cash dividends are a common example in which a public company declares a payout on each outstanding share.
  2. Influence the share price: Occasionally, if the price of a stock is too high or too low, the liquidity of the stock might suffer. Stocks priced too high will not be affordable to all investors and stocks priced too low may result in low interest from investors. An example is Sapphire Corp (SGX: NF1) where it performed a share consolidation of 1 for 20 in 2011.
  3. Corporate Restructuring: In the corporate world, mergers and acquisitions (M&A) are quite common as corporations re-structure to improve performance. Spinoffs are another example of a corporate action where a company breaks itself up in order to focus on its core competencies. For instance, Sembcorp (SGX: U96) recently listed its subsidiary, Sembcorp Salalah Power & Water on the Oman market.

Types of Corporate Actions

Corporate actions are classified as voluntary, mandatory and mandatory with choice corporate actions.

Mandatory Corporate Action: A mandatory corporate action is an event initiated by a corporation’s board of directors that involves all shareholders. Participation of shareholders is “mandatory” for these corporate actions. An example of a mandatory corporate action is the cash dividend where participation is mandatory or rather, an automated entitlement to receive the dividend payments even when shareholders do not need to do anything.

Voluntary Corporate Action: A voluntary corporate action is an action where the shareholders elect to participate in the action. These take place at an Annual General Meeting (AGM) and Extraordinary General Meeting (EGM) where shareholders have to cast their vote to approve the action.

Mandatory with Choice Corporate Action: This corporate action is mandatory, which means that shareholders are given an opportunity to choose from several options. An example is cash or stock dividend option with cash usually set as a default.

Foolish Bottom-Line

It is important for investors to understand the various types of corporate actions in order to get a clearer picture of how a company’s decisions may affect them. The type of action used can tell the investor a lot about the company, and all actions could affect the stock in some way.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.  Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.