Chapter 9: Corporate Actions – NISM-Series-XV Research Analyst Exam Study Notes Download PDF Book
Philosophy of Corporate Actions
Corporate actions are initiatives taken by a company beyond its regular business operations, which significantly affect stakeholders. These actions include dividend distribution, changes in capital structure, mergers and acquisitions, debt raising, and others. In publicly listed companies, the interests of minority investors must be safeguarded. Such actions are governed by the Companies Act, 2013, SEBI regulations, and terms of the listing agreement with stock exchanges. Corporate actions must comply with these regulations, including notification and disclosure requirements. Corporate benefits apply to all investors listed in the register of members or the register of beneficial owners for dematerialized shares. Eligibility for corporate actions is determined by the record date or book closure period.
- Dividend Distribution:Sharing surplusess with shareholders as dividends.
- Capital Structure Changes: Involves issuing more shares, share buybacks, and adjustments in equity and debt proportions.
- Mergers and Acquisitions: Combining with or acquiring other companies.
- Debt Raising: Involving the procurement of funds through debt instruments.
- Protection of Minority Investors: Ensuring the interests of small shareholders in public companies are not compromised.
- Regulatory Compliance: Adhering to the Companies Act, SEBI regulations, and stock exchange listing agreements.
- Notification and Disclosure: Informing regulators and stakeholders, and adhering to disclosure norms.
- Eligibility for Corporate Actions: Determined by the record date or book closure period; applicable to investors listed in the register of members or beneficial owners.
- Rights Issue: Offering additional shares to existing shareholders.
- Bonus Issue: Issuing extra shares to shareholders without any cost.
- Stock Split and Consolidation: Adjusting the number of shares and their face value.
- Demerger/Spin-off: Separating a company’s divisions into distinct entities.
- Scheme of Arrangement: Reorganising company structure or operations.
- Loan Restructuring: Modifying terms of existing debt obligations.
- Buyback of Shares: Company purchasing its own shares from the market.
- Delisting and Relisting of Shares: Removing and/or re-adding the company’s shares from the stock exchange.
- Share Swap: Exchanging shares as part of mergers or acquisitions.
A dividend is a portion of a company’s post-tax profits returned to shareholders. Companies may either retain these profits for business investment or distribute them equally among shareholders. Dividends can be declared as ‘interim’ during the financial year or as a ‘final dividend’ at the year’s end.
Listed companies must declare dividends in rupees per share, as mandated by SEBI, to avoid investor confusion over different face values. The payout ratio, calculated by dividing the dividend per share by the earnings per share, indicates a company’s historical dividend track record. In India, dividends exceeding Rs. 5000 are subject to a 10% tax deducted by the company under section 194 of the Income Tax Act.
- Use of Post-tax Profits: Either reinvested in the business or distributed to shareholders as dividends.
- Declaration of Dividends: Can be interim or final, and must be paid within 30 days of declaration.
- SEBI Mandate on Dividend Declaration: Requires dividends to be declared in rupee terms per share, not as a percentage of face value.
- Payout Ratio: Indicates a company’s dividend policy; calculated as dividend per share divided by earnings per share.
- Taxation on Dividends: Dividends over Rs. 5000 are subject to a 10% tax deducted by the company.
Example: If two companies, ‘A’ and ‘B’, declare a 50% dividend, but have face values of Rs. 2 and Rs. 10 respectively, the actual dividend received differs. Company ‘A’ must declare Re. 1 per share, and company ‘B’ Rs. 5 per share, to clarify the actual dividend amount to shareholders.
A Rights Issue is an approach a company uses to raise additional equity capital by offering new shares to existing shareholders first, before approaching new investors. This method is adopted to prevent the dilution of existing shareholders’ stakes. Shareholders have the option to subscribe to the shares, let the offer expire, or transfer their rights to others. The shares in a rights issue are typically offered at a discount to the market price.
- Avoiding Dilution: Rights issues help existing shareholders maintain their proportionate ownership in the company by preventing dilution from new external investors.
- Flexibility for Shareholders: Shareholders can choose to buy, ignore, or transfer their rights to buy additional shares.
- Trading of Rights Entitlements: Rights entitlements can be traded on the stock exchange for a limited period.
- Discounted Share Pricing: Shares in a rights issue are generally offered at a lower price than the current market price.
- Subscription Ratio: The number of additional shares a shareholder can purchase depends on their current holdings and the offer ratio of the rights issue.
- SEBI Regulations Compliance: Rights issues must comply with SEBI regulations, including setting a record date, issuing a detailed letter of offer, and keeping the issue open for 15 to 30 days.
- Impact on Balance Sheet: Successful rights issues result in an increase in the number of outstanding shares and a corresponding rise in cash assets.
Example: Consider a company issuing a 1-for-2 rights issue at Rs. 70 per share, and a shareholder ‘A’ with 10 shares. Here, ‘A’ can buy 5 shares (one for every two held) at Rs. 70 each. If some shareholders do not subscribe, companies may allow others to buy more than their initial entitlement.
A bonus issue, also known as an equity dividend, involves the issuance of free shares to existing shareholders. These shares are distributed without any monetary contribution from the shareholders, transferring reserves in the company’s books to paid-up/subscribed capital. This action does not affect the total value of shareholders’ holdings pre- and post-bonus issue. It is primarily a psychological influence on investors without altering the economic value.
- No Monetary Exchange: Shares are issued without any payment from shareholders.
- Source of Bonus Shares: Funded from the company’s free reserves, which are accumulated from genuine profits. Reserves from asset revaluation cannot be used for bonus issues.
- Entitlement Ratio: Determined by existing shareholding, e.g., a 1:3 bonus issue means one free share for every three shares held.
- Restrictions on Issuance: Companies cannot issue bonus shares if they have defaulted on debt payments or fixed deposits.
- Capitalization of Reserves: This increases the number of shares without impacting the company’s financial statements.
- Effect on Share Value Metrics: Per-share data (earnings per share, book value, market price) may decrease, but the overall value of shareholder holdings remains the same.
- No Change in Ownership Proportion: Shareholders’ proportionate ownership in the company remains unchanged.
Example: If a company’s share price is Rs. 1000 per share before a 1:1 bonus issue, the fair price post-bonus would adjust to approximately Rs. 500 per share. Thus, a shareholder’s holding value remains constant (e.g., 100 shares at Rs. 1000 each pre-bonus equals 200 shares at Rs. 500 each post-bonus, both totaling Rs. 1,00,000). The actual post-bonus market price will be influenced by market demand and supply but should be around Rs. 500.
A stock split is a corporate action where a company reduces the face value of its existing shares in a specified ratio. This results in an increase in the number of shares but a proportional decrease in their face value. The company’s total share capital remains unchanged, as the increase in the number of shares compensates for the reduced face value.
- Reduction in Face Value: The face value of shares is reduced, and the number of shares increases proportionally.
- Purpose of Stock Split: To make shares more affordable in the secondary market and increase investor participation due to the lower price per share.
- Impact on Share Capital: No change in the total share capital of the company, as the increased number of shares offsets the reduced face value.
- Market Liquidity: Increased liquidity in the market as more investors can afford to buy shares at the lower price.
- Psychological Influence: Aims to influence investor psychology by showing a lower market price per share.
- Effect on Share Metrics: Immediate decrease in per-share data (earning per share, book value per share, market price per share) but no economic change in the company’s profit and loss or balance sheet.
- Shareholder Ownership: Proportionate ownership of shareholders remains unchanged.
Example: If the State Bank of India (SBI) executes a stock split from a face value of Rs. 10 to Re. 1, a shareholder holding one share of Rs. 10 face value will hold 10 shares of Re. 1 face value each. If the share price was Rs. 2700 before the split, it would adjust to around Rs. 295 post-split. The value of the shareholder’s holding remains approximately the same, moving from Rs. 2700 (1 share x Rs. 2700) pre-split to Rs. 2950 (10 shares x Rs. 295) post-split. The post-split market price is influenced by market demand and supply.
Share consolidation, also known as a reverse stock split, is a process where a company increases the par value of its shares in a defined ratio while correspondingly reducing the number of outstanding shares. This action is taken to maintain the paid-up or subscribed capital of the company. It is essentially the opposite of a stock split.
- Increasing Par Value: The face value of each share increases, often by a multiple of the consolidation ratio.
- Reducing Outstanding Shares: The total number of shares decreases, typically becoming a fraction of the original number based on the consolidation ratio.
- No Change in Share Capital: Despite these adjustments, the company’s total share capital remains unchanged.
- Perception Management: Implemented when share prices are low in the secondary market, to improve the market’s perception of the company by increasing the price per share.
- No Economic Benefit to Shareholders: Like stock splits and bonus issues, share consolidation does not provide any direct economic benefit to shareholders.
- Impact on Per Share Data: Results in an immediate improvement in per-share metrics (earnings per share, book value per share, market price per share).
- Unchanged Proportionate Ownership: Shareholders’ proportional ownership in the company remains the same, despite the reduction in the number of shares they hold.
Example: If a company’s shares are trading at Rs. 5 each and it undergoes a 5:1 share consolidation, an investor with 500 shares (each valued at Rs. 5) will end up with 100 shares, each now with a face value of Rs. 25. The total value of the investor’s holding remains the same, i.e., Rs. 2,500 (pre-consolidation: 500 shares x Rs. 5; post-consolidation: 100 shares x Rs. 25). The actual post-consolidation market price will be influenced by market factors but is expected to be around Rs. 25 per share.
Merger and Acquisition (M&A)
Mergers and Acquisitions (M&A) are corporate actions leading to changes in ownership structures of companies. In a merger, one company absorbs another, with the target company ceasing to exist and its assets and liabilities taken over by the acquirer. An acquisition involves one company acquiring substantial stock of another, but both entities may continue to exist post-acquisition. Consolidation occurs when companies combine to form a new entity, resulting in the merged companies ceasing to exist.
- Types of M&A:
- Merger: Absorption of one company by another; target company ceases to exist.
- Acquisition/Takeover: Significant share purchase without necessarily dissolving the target company.
- Consolidation: Formation of a new entity from the combination of existing companies.
- Motives Behind M&A:
- Synergy: Gaining combined benefits like economies of scale and expanded markets.
- Increased Revenue and Market Share: Particularly in cases where competitors merge.
- Geographical/Other Diversification: Entering new markets or complementing existing business areas.
- Taxation Advantages: Profitable companies acquiring loss-making entities for tax benefits.
- Regulatory Aspects: SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997, govern substantial share acquisitions, offering public shareholders options in case of significant ownership changes.
Example: If a profitable Indian IT company acquires a struggling European software firm, the IT company might benefit from the tax shield provided by the losses of the European company and also gain access to new markets and technology. This acquisition could either be a complete takeover or a substantial share acquisition, depending on the strategy and agreement terms.
Demerger / Spin-off
A spin-off is a corporate action where a company separates one or more of its business units into a new, independent company. Shareholders of the parent company receive shares in the new company in a ratio proportional to their shareholding in the parent company.
- Creation of a New Entity: A separate, independent company is formed from existing business units of the parent company.
- Share Allocation to Shareholders: Shareholders of the parent company are allocated shares in the new entity, based on a predefined ratio relative to their holdings in the parent company.
- Purpose of Spin-offs: Typically done to focus on specific business areas, manage business units more effectively, or unlock hidden shareholder value.
- Record Date Importance: The eligibility for receiving shares in the new company is determined based on the shareholders’ status on a specific record date.
- Impact on Shareholders: Shareholders end up owning shares in both the parent and the newly formed company.
Example: In April 2018, Adani Enterprise spun off its renewable energy business into Adani Green Energy Limited. Shareholders of Adani Enterprises received shares in Adani Green Energy in the ratio of 761:1000. Similarly, in June 2015, Adani Enterprise spun off its ports, and power and transmission businesses into Adani Ports and Adani Transmission, respectively, each as separate companies.
Scheme of Arrangement
A Scheme of Arrangement is a court-supervised agreement process between a company and its creditors or certain classes of shareholders, often used in situations where the company fails to meet its obligations. This arrangement usually involves the reorganisation of the company’s share capital and can include actions like shareholders relinquishing part of their ownership to creditors or altering the classification of shares.
- Purpose: Used when companies can’t fulfil obligations to creditors or certain shareholder classes (e.g., failing to redeem preference shares).
- Court Supervision: Managed under the oversight of a court, ensuring fairness and legality.
- Share Capital Reorganisation: May involve changes in ownership structure or share classification.
- Legal Framework: Governed by Section 230 of the Companies Act, 2013 in India.
- Initiation Process: Can be initiated by the company itself or its creditors/members.
- Involvement of National Company Law Tribunal (NCLT): The party seeking the arrangement must approach the NCLT, which then orders a meeting between the company and its creditors/members to reach a compromise or arrangement.
- Compromise or Arrangement: Aims to reach an agreement that satisfies all parties involved, typically leading to a restructuring of financial obligations or shareholdings.
Example: If a company is unable to redeem its preference shares, it might propose a scheme of arrangement where preference shareholders agree to convert their shares into a different class of shares or accept a delayed redemption schedule. This would be done under the supervision of the NCLT to ensure a fair and legal resolution.
Loan restructuring refers to the process where companies facing financial difficulties renegotiate and modify the terms of their loans with lenders. This can include changes to the loan amount, interest rate, repayment mode, and loan duration, aligning the repayment obligations with the borrower’s current financial capacity.
- Applicability: Aimed at companies unable to meet their existing loan obligations.
- Modification of Loan Terms: Can involve altering the loan amount, interest rates, repayment methods (which may include converting debt to equity), and extending the loan term.
- Mutual Benefit for Borrower and Lender: Helps the borrower avoid default and allows the lender to recover a portion of the loan that might otherwise be written off.
- Business Recovery Focus: Enables the borrower to concentrate on business revival and balance sheet improvement.
- Process of Restructuring:
- Debt Analysis: Assessing the company’s current debt situation.
- Negotiations with Lenders: Discussing possible changes to loan terms.
- Financial Information Sharing: Providing lenders with details on the company’s current and projected financial status.
- Development of a Repayment Plan: Creating a feasible plan for loan repayment under the new terms.
- Presentation of a Business Plan: Demonstrating how the company will generate revenue to fulfill its obligations and sustain business operations under the restructured terms.
Example: Consider a company that has taken a loan at a 10% interest rate, repayable over 5 years. Facing financial difficulties, it negotiates with the lender to extend the term to 10 years and reduce the interest rate to 6%, thereby lowering its monthly repayments and aligning them with its current financial capacity.
Buyback of Shares
A buyback of shares is a corporate financial strategy where a company purchases its own shares from shareholders. This action reduces the total number of shares in circulation, utilising the company’s reserves and surplus for the transaction. Share buybacks can be motivated by various factors, including perceived undervaluation of the stock, excess cash, investment strategy, defensive measures against takeovers, or adjusting corporate leverage.
- Use of Excess Cash: Options include expanding business, reducing liabilities, or distributing to shareholders via dividends or share buybacks.
- Motives for Share Buyback:
- Enhance stock value if undervalued.
- Utilise surplus cash when lacking profitable investment opportunities.
- Boost investor confidence.
- Defend against potential takeovers.
- Increase company leverage by reducing equity.
- Counter dilution effects from ESOPs.
- Funding Source: Buybacks are financed from the company’s reserves and surplus.
- Share Cancellation: Bought-back shares are extinguished, reducing the company’s share capital.
- Eligibility Criteria: The company should not have defaulted on debt or dividend payments.
- Buyback Methods:
- Tender offer to shareholders.
- Open market purchases through book-building or stock exchanges.
- Targeting odd lot holders.
- Special Resolution Requirements: Companies must pass a special resolution outlining the buyback timeframe and maximum price.
- Impact on Shareholders:
- Reduction in outstanding shares increases Earnings Per Share (EPS).
- Potentially higher dividend per remaining share.
- Increase in market value per share if overall company earnings remain constant.
Example: If a company’s stock is undervalued at Rs. 100 per share, it might initiate a buyback to reduce the number of shares in circulation, thereby increasing the EPS and potentially raising the stock price. This could also signal confidence to the market, possibly attracting more investors.
Delisting and Relisting of Shares
Delisting of shares refers to the removal of a company’s shares from a stock exchange. It can be either compulsory, due to non-compliance with regulations, or voluntary, where the company chooses to go private. Relisting is the process of a previously delisted company returning its shares to public trading on a stock exchange, subject to regulatory conditions and timeframes.
- Types of Delisting:
- Compulsory Delisting: Due to regulatory non-compliance.
- Voluntary Delisting: Company’s decision to go private, influenced by various motives like reducing regulatory complexities or implementing new strategies.
- SEBI Regulations for Voluntary Delisting:
- Requirement to provide an exit opportunity to all shareholders.
- Promoter group must acquire shares via a reverse book-building process, setting a floor price.
- Options for promoters include accepting bid price, rejecting it, or making a counteroffer.
- Delisting only possible if promoter holding crosses 90% and at least 25% of public shareholders participate.
- Exit Rights for Remaining Shareholders: Post-delisting, remaining public shareholders can sell their shares to the promoters at the exit price within one year.
- Protection of Minority Shareholders: Cannot be forced to exit at the time of delisting.
- Relisting of Shares:
- Governed by SEBI regulations.
- Possible after a minimum period: 5 years for voluntary delisting, 10 years for compulsory delisting.
Example: A company voluntarily delisting might offer to buy back shares from existing shareholders at a predetermined price through reverse book building. If the promoter’s stake reaches 90% and sufficient public shareholder participation is met, the delisting can proceed. Post-delisting, if some public shareholders still hold shares, they can sell these to the promoters at the agreed exit price within a year. For relisting, the company must wait for at least five years post a voluntary delisting before it can apply to list its shares on the stock exchange again.
A share swap is a process where one set of shares is exchanged for another. This term is frequently used in mergers and acquisitions, where the acquiring company offers its own stock as a means of payment to purchase another company. In this arrangement, shareholders of the acquired company receive a predetermined number of shares from the acquiring company.
- Definition of Swap: In the context of shares, it means the exchange of one set of shares for another.
- Use in Mergers and Acquisitions: Predominantly used when a company acquires another and pays for the acquisition with its own shares.
- Shareholder Compensation: Shareholders of the acquired company are compensated with shares of the acquiring company.
- Valuation Requirement: Both companies must be accurately valued to determine a fair swap ratio.
- Fair Swap Ratio: A critical element, ensuring that the exchange of shares reflects the true value of both companies involved.
Example: Consider a scenario where Company A acquires Company B. Company A issues its shares to the shareholders of Company B. If the agreed swap ratio is 1:2, for every share a Company B shareholder owns, they would receive two shares of Company A. This swap ratio would be based on the valuation of both companies to ensure a fair exchange.