What Are Corporate Actions?

When a publicly traded company announces a corporate action, the savvy investor knows it's an event likely to impact the stock price. If you're a shareholder or considering buying shares of a company, you need to understand how an action will affect the company's stock. Corporate actions can also indicate a company's financial health and its prospects in the near term.

Corporate Action Examples

The Stock Split

A stock split, sometimes called a bonus share, divides the value of each of a company's outstanding shares. The most common type of stock split is a two-for-one split. In this scenario, an investor initially holding one share would automatically own two shares afterward, with each new share being worth half the value of the original share.

While it may appear that the company has halved its stock price, the market often adjusts the price upward soon after the split occurs. There are short-term effects to consider:

• Current shareholders feel rewarded as they now hold more shares.
• Potential buyers often find the lower share price more accessible, spurring interest in the stock.

Despite the doubling of common stock shares, it's crucial to remember that a stock split is a “nonevent” in financial terms. It doesn't change the company's overall equity or its market capitalization; only the number of shares outstanding is altered. But there may be long-term implications:

• Stock splits are gratifying to shareholders, immediately and in the longer term. After that initial pop, they often increase stock prices over time.
• However, cautious investors may express concern over multiple stock splits, fearing that an excess of shares could dilute value.

The Reverse Split

A reverse stock split is an action initiated by a company seeking to elevate its share price. Unlike a traditional stock split, a reverse split consolidates shares, effectively reducing the number of shares an investor holds while increasing the value of each share. For example, an investor holding 10 shares valued at $1 each would, after a 10-for-1 reverse split, own just one share valued at $10.

There could be several reasons for a company to engage in a reverse split. First, when a company's stock price has fallen very low, this could prompt the company to boost its value artificially to avoid the stigma or regulatory restrictions associated with being labeled a penny stock. The company might also be looking to attract institutional investors who would otherwise avoid lower-priced shares.

There are further implications to consider. A reverse split is often seen as an attempt by the company to improve its financial image, although it doesn't change the firm's market capitalization. In some instances, the maneuver is used strategically to sift out smaller investors who may not be part of the company's long-term plans.

Dividends

Companies can issue dividends in two forms: cash or stock, usually distributed on a quarterly or annual basis. Essentially, these are a share of the company's profits being paid to owners of the stock.

Dividend payments affect the equity of a company. The distributable equity (retained earnings or paid-in capital) is reduced.

When a company issues a cash dividend, each shareholder receives a set amount of money per share owned. For example, if a shareholder owns 100 shares and the cash dividend is $0.50 per share, they would receive $50. Cash dividends often signal that a company has a strong financial standing with a healthy level of retained earnings.

On the other hand, stock dividends involve distributing additional shares to existing shareholders. If the dividend rate is set at 10%, a shareholder would receive one additional share for every 10 shares owned. However, this increases the total number of outstanding shares and dilutes earnings per share, typically causing the stock price to adjust downward.

The distribution of dividends can provide significant insight into a company’s financial health. Cash dividends suggest that the company has significant retained earnings and expects to maintain its financial performance by replacing the outgoing funds. Alternatively, when a company known for rapid growth begins issuing dividends, many investors interpret this as a sign that the company is transitioning to a more stable but slower rate of growth.

Rights Issues

In a rights issue, a company extends an offer exclusively to its current shareholders for new or additional shares, giving them the first opportunity to purchase or acquire these shares before making them available publicly.

A rights issue frequently occurs in the form of a stock split. Implementing a rights issue usually signals that the company is providing its existing shareholders a unique benefit from a forthcoming positive development or venture.

Mergers and Acquisitions

A merger occurs when two or more companies combine and all parties involved have agreed to the terms. Formally, one company surrenders its stock to the other.

Shareholders may interpret a merger in two ways: either as a strategic move for business expansion or as an indication that the industry is consolidating, compelling the company to absorb competitors to maintain growth.

An acquisition differs from a merger in that one company purchases a majority stake in another firm without merging or swapping shares. Acquisitions can be friendly or hostile.

A unique variation is the reverse merger, where a privately held company acquires a publicly traded company, generally one that's struggling. Through this transaction, the private company essentially becomes public, sidestepping the cumbersome process of undertaking an initial public offering. Afterward, it may rebrand itself and issue new shares.

Contingent Value Right (CVR):

A CVR guarantees that shareholders will get compensation if a specified event occurs within a predetermined time frame. These rights are commonly issued in situations involving corporate restructuring or a buyout.

A CVR may be issued during an acquisition, acting as a negotiating tool when the acquiring and target companies disagree on the target’s fair price. Essentially, CVRs bridge this gap. If the acquired company hits specific performance measures after the acquisition, the acquiring company is obligated to grant additional benefits to the target’s shareholders.

CVR rewards either come in the form of cash or stock. When the compensation is stock, as is often the case, the value of the CVR can be harder to determine. That’s because share prices regularly change. For instance, shares valued at $100 each at the time of the deal could later fluctuate, making the value of the CVR hard to pin down when performance targets are eventually met.

The Spinoff

A spinoff occurs when a publicly traded company either sells off ("divests") part of its assets or issues new shares to form a separate company. Divesting, in this context, means to get rid of certain assets, businesses, or holdings to streamline operations or refocus the company's strategy.

Commonly, the company will offer these newly issued shares to its shareholders first, typically through a rights issue, before making them available to new investors. The decision to carry out a spinoff could indicate that the company is either preparing for new growth ventures or centering its efforts on its main line of business.

Name/Symbol Change

Companies sometimes change their name and ticker symbol. They could be getting acquired, changing the focus of the business, or may wish to rebrand, perhaps to distance themselves from past errors or events associated with the corporate name.

After a merger, one or both companies need to change their name and symbol. For example, in 2000, Bell Atlantic acquired GTE and changed its name to Verizon Communications. A shift in business focus can also be a good reason for a change, particularly if the old name is no longer relevant or doesn’t capture fully what the company presently does. One instance is Apple Computer, Inc. changing its name to simply Apple, Inc. in 2007, given its vast expansion into smartphones and other media technology.

Rebranding, too, which can involve a name change, is sometimes found necessary given public sentiment. A notable example is Philip Morris Companies, which changed to the Altria Group in 2003, distancing the corporate identity from the negative public perception of tobacco and its related health risks and as part of an effort to diversify its holdings.

That doesn’t mean name and symbol changes should be done hastily for better marketing or public relations. Names and ticker symbols identify the company and shouldn’t be changed lightly. Going under a different name or ticker could confuse people, raise suspicion, and result in lost business.

Liquidation

Sometimes, a company can no longer meet its financial obligations and is forced to enter liquidation. Its assets are then sold off, and the proceeds are distributed to eligible claimants.

Liquidation, obviously, is not a good thing for most shareholders. Once it happens, the shares will stop trading and are deemed worthless. Since ordinary shareholders rank bottom on the list of people to creditors, they are unlikely to receive anything from the sales of company assets.

The Bottom Line

Corporate actions can significantly impact a company’s prospects and share price, so shareholders and investors should keep tabs on them. These events typically need approval by the board of directors and may even require a thumbs up from shareholders.

Corporate actions can be voluntary or mandatory and good or bad. In most cases, activities such as dividend payments, buybacks, and anything else seeking to boost shareholder value are welcome unless investors feel the company’s assets could have been used better. Less welcome are rights issues and liquidation. Investors generally loathe these events.