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The most common corporate actions are stock split, bonus issue, rights issue, cash dividend and stock dividend.
Stock Split
A 2-for-1 stock split means that every share will be split into 2. This does not affect the net worth of the stock owner.
A company with 1,000,000 outstanding shares in the market will increase to 2,000,000 shares after a 2-for-1 stock split. The price will be reduced by half; therefore, if the share price is $50 before the stock split, then the new price will be $25.
The purpose of such an exercise is to increase liquidity as more shares are circulated in the market while the value of the equity does not change.
The effect of stock split is that the par value of each stock is reduced; there is no change in capital reserve of the company and there is no change in the shareholder’s net worth.
Bonus Issue
Bonus issue is similar to stock split except that the additional share is not split from existing share but it is funded by capital reserve or retained earnings.
A 1 for 1 bonus issue means that a company give addition share for each share a stock holder owned. A company with 1,000,000 outstanding shares in the market will increase to 2,000,000 shares after a 1-for-1 bonus issue. The price will be reduced by half; therefore, if the share price is $50 before the bonus issue, then the new price will be $25. However, the capital reserve or retained earnings will be reduced.
The effect of bonus issue is that the par value of each stock remains unchanged; there is a reduction in capital reserve of the company and there is no change in the shareholder’s net worth.
Stock Dividend
Stock dividend is another way for a company to pay shareholders from its capital reserve. However, stock dividends are given more regularly than bonus issue.
Similarly stock dividend will result in reduction of price since additional stock is being paid out from the capital reserve.
A company with 1,000,000 shares announce a stock dividend of 5%. This means that every stock owner would received 5 shares for every 100 shares owned. The total shares of the company will be 1,050,000. If an investor owned 1000 shares, then the total share ownership will be 1050. Similar to bonus issue, it will not increase the net worth as the price will be adjusted lower to account for the dividend issue. If the share price is $50 then the new share price is $47.50.
The effect of stock dividend is that the par value of each stock remains unchanged; there is a reduction in capital reserve of the company and there is no change in the shareholder’s net worth.
Cash Dividend
Cash dividend is another payout from the company to shareholders. However, the payout is in cash instead of stocks.
A company announce is $0.10 per share dividend. This means that for every share owned by an investor, he will received 10cents. If the investor owned 10,000 shares, then he would receive a cash dividend of $1000. Since the cash was taken from the company’s capital reverse, the price of the share would reduce to account for the cash withdrawal.
The effect of cash dividend is that there is a reduction in capital reserve of the company and there is no change in the shareholder’s net worth except that a small portion of it is in cash.
Some company introduces a dividend reinvest program where investor can use the dividend to buy additional shares. The effect of such program is the same as stock dividend.
Rights Issue
Rights issue is a way for a public company to raise additional capital from the existing shareholders at a discounted price.
Investor’s Point of View
Assuming a company X has a current market capitalization of $5 billion shares with 100 million shares traded at $50 per share. Assuming that the company announce a 1-for-5 rights issue at a discounted rate of $35 per share; if an investor owned 100,000 shares, this means that the investor has the right to buy 20,000 shares at $35 each.
If the investor exercised the rights, then his total net worth would be $5,000,000 + $700,000 = $5,700,000. The adjusted share price after rights issue would be $47.5 (5700000/120000).
If the investor bought the original 100,000 share at $50, this means that there is no gain in his investment even after the price was adjusted for rights issue. However, his cost would be $47.5 instead of $50.
The rights issue can be bought and sold in the market price at the difference between $50 and $35 = $15.
Should the investor decided not to exercise the rights, his share would be diluted. Therefore it is wise for the investor to sell the rights issue for $15 to other investors in order to avoid dilution of his holdings.
Company’s point of View
Based on the above example, the company would be raising $700 million dollars from existing shareholder. The total outstanding share would be 120 million shares and total market capitalization would be 5.7 billion. The effective share price would be adjusted to $47.50.
Corporate Action and Back Office
As the actual corporate action is done by the custodian, back office need to replicate the computation in order to maintain a reconciled position with the custodian bank. We can buy corporation action data from independent data providers such as FTID.
Such corporate action data will be uploaded to the system and the system would compute the receivables automatically. If there is a discrepancy between the custodian and investment firm, the usual practice is to adopt the estimates from the custodian.
The computations of receivables are usually a close estimates. The actual receipt of cash or dividend may vary slightly due to rounding at various stages.
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