What is a Corporate Action?

Corporate Action Details

Corporate action may come in a lot of forms. Some examples include declaring bankruptcy, a merger, acquisition, stock split, or even changing the name and/or logo of the corporation. Issuing a corporate action will undoubtedly affect securities, no matter how big or small it is. Put another way, corporate action is any visible action that would materially alter the company.

Since public corporations take corporate actions, the boards of directors — as the shareholders’ representatives — are the ones who oversee the change. The board usually votes to approve any corporate action. In some cases, shareholders may also have the opportunity to authorize and vote on the decision. Whether shareholders have this power or not depends on the type of corporate action the organization is about to take.

Example of Corporate Action

One of the most common corporate actions is stock split. A stock split is splitting the value of each of the company’s outstanding shares (all of the stocks currently held by shareholders). By dividing or splitting the stock, the company effectively reduces the price of its share by half while also increasing its numbers by twice as many. Usually, the market will respond to this event by adjusting the common stock shares’ price upwards, benefitting the current shareholders while also attracting more prospective buyers.

The exact opposite of stock split is reserve split, which consolidates several outstanding shares into fewer amounts. A reverse split is done usually as an instant measure to jack up the stock price, making the stock’s value appear stronger. If you see a company taking such corporate action, it could be a sign of financial distress. Otherwise, it could be that the board of directors wishes to reduce the number of small investors.

Another prevalent corporate action is dividends. A dividend is the sharing of a company’s earnings to the owners of its stock, usually on an annual or quarterly basis. There are two types of dividends: cash dividend and stock dividend. In cash dividend, shareholders are paid a certain cash amount based on per share calculation, whereas stock dividend gives the shareholders additional stocks depending on the number of stocks currently held.

Types of Corporate Action

Overall, there are two types of corporate action: mandatory corporate action and voluntary corporate action. Mandatory corporate actions are events that are done without shareholders’ approval. On the other hand, voluntary actions are activities requiring the investors’ authorization. On the example above, stock split, reverse split, and dividends are all mandatory, whereas voluntary actions include activities such as tender offer.

Mandatory actions don’t take into account what the majority of shareholders wish since the board of directors is the only one that has the voting right. That said, some mandatory actions still give the shareholders options. For instance, in the case of dividends, shareholders may choose between cash dividends or stock dividends. Cash dividends are often the go-to choice, though stock dividends increase the number of stocks the shareholders hold.

A corporate action can become voluntary due to the nature of the action. For example, a tender offer is a public proposal or solicitation to all of a company’s shareholders to sell their stocks, usually at a higher price than the normal value, during a certain period. Investors often issue a tender offer in a takeover attempt, seeking to gain control of the company by acquiring the majority of its shares. In this case, shareholders have the freedom to choose whether to sell their stocks or not, although the incentive to sell is bigger due to the premium price.

Significance of Corporate Action

If you are a shareholder or someone interested in buying a share of a company, you need to keep in mind how a corporate action will affect you as well. Since the level of the company’s security (debt or equity) will inevitably change, this will also affect the stock price. Corporate action can also be an indication of a company’s financial situation as well as its plan for the future.