LEARNING OBJECTIVES:
After studying this chapter, you should know about the following corporate actions and
their implications:
Dividends
Rights Issue
Bonus Issue
Stock Split and Consolidation
Mergers and acquisition
Demerger / Spin-off
Scheme of arrangement
Loan restructuring
Buyback of shares
Delisting and relisting of shares
Share swap
9.1 Philosophy of Corporate Actions
A company initiates several actions, apart from those related to its business, that have a direct
implication for its stakeholders. These include sharing of surplus with the shareholders in the
form of dividend, changes in the capital structure through the further issue of shares, buy
backs, mergers and acquisitions and delisting, raising debt and others. In a company that has
made a public issue of shares, the interest of the minority investors has to be protected.
Corporate actions are regulated by provisions of the following:
Provisions of the Companies Act, 2013,
Relevant regulations of SEBI, and
Terms of the listing agreement entered into with the stock exchange
All corporate actions therefore need to follow the requirements prescribed by these
regulations. This includes giving notice to the regulators, stake holders and following the
disclosure norms laid down in the applicable clauses.
Corporate benefits and actions, as defined above, apply to all investors who appear in the
register of members, if the shares are held in physical form or investors whose names appear in
the register of beneficial owners maintained by the depository, in case of dematerialized
shares. In order to determine this, the company announces a record date or book closure
period and investors whose names appear on the records on this date become eligible
shareholders to receive notice of the relevant corporate action and benefit.
There are several corporate actions possible and some of them are defined below:
9.2 Dividend
Post-tax Profits in a business belong to the shareholders and a company can broadly do two
things with those profits – retain them for investment in the business, or return to the
shareholders. If a company chooses to return money to all shareholders in equal proposition, it
is said to have ‘declared a dividend’. In practice, companies distribute part of the profits and
retain part of the profits in the business. The proportion of distribution and retention of profits
will depend upon the opportunities available for ploughing back the profits into the business,
nature of management, expectation of shareholders and ultimately the availability of cash in
the business to distribute to the shareholders. A company may declare ‘interim dividends’
during the financial year and a ‘final dividend’ at the end of the year. A company has to pay
dividends within 30 days of its declaration.
SEBI has mandated that listed companies shall declare dividends in rupees terms on per share
basis as against the earlier practice of declaring dividends as a percentage of the face value.
This is to avoid confusion among investors while comparing dividend on various shares of
different face values.
For example: if 50% dividend is declared by two companies ‘A’ and ‘B’ with different face values
of Rs.2 and Rs.10 respectively, an investor in company ‘A’ will receive Re. 1 as dividend as
against Rs. 5 in the case of company ‘B’. Dividends received by the investors in two companies
are different even though the percentage is the same because the face value of the shares is
different. In the interest of the investors, company ‘A’ is now required to declare the dividend
as Re. 1 per share while company ‘B’ will declare the dividend payable as Rs. 5 per share.
Historical dividend track record of a company may be seen from Payout ratio, which is
calculated by dividing the company’s dividend per share by earnings per share. In India,
companies declaring or distributing dividend, are required to pay Dividend Distribution Tax in
addition to the tax levied on their income. Dividend received is exempt in the hands of the
shareholder’s, in respect of which Dividend Distribution Tax has already been paid by the
company.
9.3 Rights Issue
When a company needs additional equity capital, it has two choices – ask more money from
existing shareholders or go for fresh set of investors. If company chooses latter i.e. issues
shares to fresh set of investors, proportionate holding of existing shareholders gets diluted. For
example, a company may have 10 lakhs shares of Rs.10 each, amounting to an issued and paidup capital of Rs. 1 crore. If it issues another 10 lakhs shares to fresh set of investors, to increase
its capital, the proportion held by existing shareholders will come down by half, as the issued
and paid up capital has doubled. This is called as dilution of holdings. To prevent this,
Companies Act requires that a company which wants to raise more capital through an issue of
shares must first offer them to the existing shareholders and such an offer of shares is called a
rights issue.
Subscribing to the rights issue is choice and not compulsion for investors. They may buy shares
offered to them under rights issue or let the choice expire without any action or may choose to
transfer their rights/entitlement to another person for consideration (sell) or without
consideration (under love and affection). This is called renunciation of rights. Rights
entitlements also get traded on the stock exchange for a defined period.
Shares under rights issues are generally offered at a discount to the prevailing market prices
(Logically also, if price under a rights issue is higher than market price of stock, investors would
be better off buying shares from the market without subscribing to the issue). Let us assume a
shareholder ‘A’ has 10 shares of a company whose share price is Rs.100. If the company is in
further need of capital, it could get this capital from its existing shareholders by offering shares
at a discounted price. The number of discounted shares a shareholder can buy depends on the
number of shares held by him and the ratio offered under rights issue.
For example: if the company issues 1-for-2 rights issue at Rs.70 per share, shareholder ‘A’ will
have right to buy one share for every two shares held by him at Rs. 70. As ‘A’ has 10 shares, he
can buy 5 more shares at Rs. 70. In practice, companies allow shareholders to apply for
additional shares beyond their entitlement because some shareholders may neither apply for
shares under their entitlement nor transfer their rights to others and those shares may be
available for issuance to these shareholders who desire additional shares.
A rights issue of shares must follow all SEBI’s regulation on issue of shares. A listed company
making a rights issue shall fix a record date to determine the eligibility to the rights. The
company must issue a letter of offer giving details of the issue including the purpose for which
funds are being raised. The draft letter of offer must be filed with SEBI. An abridged letter of
offer must be dispatched to all investors at least three days before the issue opens. Investors
can also apply on a plain paper if they do not receive the application form. A rights issue is open
for subscription for a minimum period of 15 days and a maximum period of 30 days.
As a result of rights issue, total number of outstanding shares goes up with a corresponding
increase in the cash in the asset side of the balance sheet. If all shareholders subscribe to their
full entitlements/rights, their proportionate ownership remains unchanged and the number of
shares held by them goes up.
9.4 Bonus Issue
A bonus issue, also known as equity dividend, is an alternative to cash dividend. Bonus shares
are issued to the existing shareholders by the company without any consideration from them.
The reserves lying in the books of the company (shareholders’ money) gets transferred to
another head i.e. paid-up/subscribed capital. The shareholders do not pay anything for these
shares and there is no change in the value of their holdings in the pre and post-bonus stages.
The issuance of bonus shares is more to influence the psychology of investors without any
economic impact.
The entitlement to the bonus shares depends upon the existing shareholding of the investors. A
bonus issue in the ratio of 1:3 entitles a shareholder for 1 bonus share for every 3 shares held
by them. The company makes the bonus issue out of its free reserves built from genuine
profits. Reserves built from revaluation of assets are not allowed to be considered for making a
bonus issue. A company cannot make bonus issue if it has defaulted on payment of interest
and/or principal on any debt security issued or any fixed deposit raised.
Issuance of bonus shares is termed as capitalization of reserves. As total number of shares go
up without any economic change in the profit and loss statement or balance sheet, per share
data (earning per share, book value per share, market price per share etc.) witnesses
immediate deterioration. However, as shareholders’ proportionate ownership remains
unchanged and the number of shares held by them go up, at overall ownership level, there is
no negative impact to the shareholders.
For example: If shares of a company were trading at a price of Rs. 1000 per share prior to
bonus, post bonus on 1:1 basis, fair price of share is likely to come down to Rs. 500 per share to
maintain post bonus market value of a holding equivalent to its pre bonus market value.
Therefore, mathematically, the value of the investor’s holding pre bonus at Rs. 1, 00,000 (100
shares x Rs. 1000) remains the same Rs. 1, 00,000 (200 shares x Rs. 500) post bonus. Actual
market price of share post bonus will be around Rs. 500 (not exactly at of Rs. 500) as it will
depend on market factors of demand and supply.
9.5 Stock Split
A stock split is a corporate action where the face value of the existing shares is reduced in a
defined ratio. A stock split of 1:5 means split of an existing share into 5 shares. Accordingly, face
value of shares will go down to 1/5th of the original face value. For example, if an investor holds
100 shares of a company with a face value of Rs.10 each, a stock split in the ratio of 1:5 will
increase the number of shares held by him to 500 but the face value of each share will go down
to Rs. 2. From the company’s perspective, there is no change in its share capital since an
increase in the number of shares is offset by a fall in the face value and resultant multiplier of
face value and outstanding no. of shares remains the same.
Companies consider splitting their shares if prices of their shares in the secondary market are
seen to be very high restricting the participation by investors. As price per share comes down
post-split, share split leads to greater liquidity in the market.
Similar to bonus, split is also a book entry resulting in increased number of outstanding shares
in the books of company with reduced face value without any economic benefit whatsoever to
the shareholders. We may say that share split is also to influence the psychology of investors (of
reduced market price per share) and to impact liquidity in the market place without any
economic benefit to the shareholders. As the total number of shares go up without any
economic change in the Profit and Loss statement or Balance Sheet, per share data (earning per
share, book value per share, market price per share etc.) witnesses immediate deterioration.
However, as shareholders’ proportionate ownership remains unchanged and number of shares
held by them go up, at overall ownership level, there is no negative impact to the shareholders.
For example, SBI initiated a stock split of its equity shares from a face value of Rs.10 to Re.1. A
shareholder holding 1 share of a face value of Rs.10 will now hold 10 shares each with a face
value of Re.1. The stock that was trading in the markets at over Rs.2700 at the time of the
announcement traded post-split at around Rs.295. The value of the shareholder’s holding was
around Rs.2700 (1 share x Rs.2700) prior to the stock split. Post the split, the value of the
holding is Rs. 2950 (10 shares x Rs.295). The market price after the split will depend upon the
market forces of demand and supply.
9.6 Share Consolidation
Share consolidation is the reverse of stock split. In a share consolidation, the company changes
the structure of its share capital by increasing the par value of its shares in a defined ratio and
correspondingly reducing the number of shares outstanding to maintain the paid up/subscribed
capital. A stock consolidation of 5:1 means consolidation of 5 existing share into 1 share.
Accordingly, face value of shares will go up 5 times of the original face value and no. of
outstanding shares will become one fifth the original number.
For example, if an investor holds 500 shares of a company with face value of Rs.2 each, a stock
consolidation in the ratio of 5:1 will reduce the number of shares held by him to 100 but the
face value of each share will go up to Rs. 10. From the company’s perspective, there is no
change in its share capital since decrease in the number of shares is offset by corresponding
increase in the face value.
Companies consider consolidating their shares if prices of their shares in the secondary market
are seen to be very low effecting the perception of investors. An increase in the price per share
post- consolidation, leads to better perception among the market participants about the
company’s prospects.
Similar to bonus and split, share consolidation is also a book entry resulting in reduced number
of outstanding shares in the books of company with increased face value without any economic
benefit whatsoever to the shareholders. We may say that share consolidation is also to
influence the psychology of investors without any economic benefit to the shareholders. As
total no. of shares go down without any economic change in the Profit and Loss account or
Balance Sheet, per share data (earning per share, book value per share, market price per share
etc.) witnesses immediate improvement. However, as shareholders’ proportionate ownership
remains unchanged and no. of shares held by them go down, at overall ownership level, there is
no positive impact to the shareholders.
For example: If shares of a company were trading at a price of Rs. 5 per share prior to
consolidation, post- consolidation on 5:1 basis, fair price of share is likely to become Rs. 25 per
share to maintain post- consolidation market value of a holding equivalent to its preconsolidation market value. Therefore, mathematically, value of the investor’s holding preconsolidation Rs. 2,500 (500 shares x Rs. 5) remains the same at Rs. 2,500 (100 shares x Rs. 25)
post- consolidation. Actual market price of share post- consolidation will be around Rs. 25 (not
exactly at Rs. 25) as it will depend on market factors of demand and supply.
9.7 Merger and Acquisition
Mergers, acquisitions and consolidations are corporate actions which result in a change in the
ownership structure of the companies involved. In a merger, the acquirer buys up the shares of
the target company and it is absorbed into the acquiring company and ceases to exist. The
assets and liabilities of the target company are taken over by the acquirer. In an acquisition or
takeover, the acquiring company acquires all or a substantial portion of the stock of the target
company. Both entities typically continue to exist after the acquisition. In a consolidation,
companies combine together to form a new company and the merged companies cease to
exist.
Following are some of the motives behind M&A activities:
Synergy: Each company may have distinct efficiencies that when combined together may
result in greater economic benefits. The combined entity can benefit from economies of
scale, forward and backward integration and expanding the market for their products and
services.
Increased revenue and market share: If two competitors go through M&A, it would result
in increased revenue and market share for the acquiring entity.
Geographical or other diversification: Acquiring Company (or Companies) in different
geography or complimentary business space may offer significant competitive advantage to
the acquirer.
Taxation: A profitable company can buy a loss making company to enjoy tax shield against
the losses of the target company.
The shareholding pattern of a listed company may change due to a substantial acquisition of
shares and voting rights by an acquirer and persons acting in concert with the acquirer. SEBI
(Substantial Acquisition of Shares and Takeover) Regulations, 1997, provide relevant triggers
and requirements for an acquirer and offer an opportunity to public shareholders to exit from
the company in such situations, if they choose to do so.
9.8 Demerger / Spin-off
A spin-off occurs when a company carves one or more of its existing business on to a separate
company. In case of a spin-off, the shareholders on the record date will be eligible to receive
shares in the new company in proportion to the shares they held in the parent company.
For example, in April 2018, Adani Enterprise spun-off its renewable energy business to a new
company Adani Green Energy Limited. Shareholders of Adani Enterprises were given shares in
the new company is the ratio of 761:1000. Earlier, in June 2015, Adani Enterprise spun-off its
ports, and power and transmission businesses into two separate companies: Adani Ports and
Adani Transmission, respectively.
9.9 Scheme of arrangement
Some companies may fail to fulfill its obligation to its creditors or to certain class of
shareholders (example: failure to redeem preference shareholders). Under such conditions,
company and the creditors or members may enter into a scheme of arrangement to settle the
issue.
Scheme of arrangement is a court monitored settlement process between the company and its
creditors or members. It typically involves reorganization of the share capital of the company. It
may involve the existing shareholder’s relinquishing part of their ownership in favor of the
creditors or consolidation or division of class of shares.
Under section 230 of Companies Act 2013, Scheme of arrangement can be sought by the
company or its creditors / members. The person claiming the scheme of arrangement shall
approach the National Company Law Tribunal (NCLT). The tribunal then orders the meeting
between the company, its creditors and/or members to arrive a compromise or arrangement.
9.10 Loan Restructuring
Loan or debt restructuring is a mechanism available to companies in financial distress who are
unable to meet their obligations to their lenders to restructure their debt by modifying one or
more of the terms of the loans. This may include the amount of loan, rate of interest, the mode
of repayment: funds and/or equity in the company, and the term of the loan and so that the
repayment obligation is within the payment capacity of the borrower. A restructuring exercise
is to the advantage of the borrower and the lender. The borrower is given a way to repay the
loan that is feasible given the current state of the business and not be declared a defaulter. The
company is now able to focus on building back its business and repairing the balance sheet. The
lender can expect some repayment from a loan that would otherwise have to be written off as
a bad debt.
The process of debt restructuring involves analyzing the debt position of the company, meeting
with the lenders, providing information on the current and future financial position of the
company and coming up with a workable repayment plan. The lenders have to be provided a
concrete business plan on how the company plans to generate the revenues required to meet
its obligations under the new terms as well as meet the financial needs of the business.
9.11 Buyback of Shares
A company may deploy excess cash on the balance sheet in various ways. It may use the money
to expand business and grow or reduce its liability by paying back/reducing its borrowings, if
any, and/or to distribute to the shareholders. If it chooses the third option, management needs
to choose between homogenous distribution of this money among all shareholders through
dividend or it would offer a choice to the shareholders to have the money through selling their
shares back to the business or in kind in terms of enhanced value of each share in terms of
Earning Per Share (EPS) and Book Value Per Share (BV).
Motives of buy back of shares could be multiple as follows:
To give a value boost to the stock if it is seen as undervalued.
Excess cash and lack of profitable investment opportunities.
Buyback as a confidence building measure.
Buyback as a defensive strategy against a potential takeover.
Buyback to reduce equity and resultantly increase the leverage in the company.
Buyback to diffuse the impact of dilution in promoters’ holding on account of say Employee
Stock Option Plans (ESOPs).
While every management talks about the positive impact of buyback on minority shareholders,
it is very difficult to ascertain management intention on buyback of shares.
Buyback of shares can be done only out of the reserves and surplus available with the company.
The shares bought back are extinguished by the company within stipulated time frame and that
leads to a reduction in its share capital. To be eligible for a share buyback, a company should
not have defaulted on its payment of interest or principal on debentures/fixed deposits/any
other borrowings, redemption of preference shares or payment of dividend declared.
The shares can be bought back using the tender method by making an offer to existing
shareholders on a proportionate basis or from the open market through a book building
process or through the stock exchange or from odd lot holders. The company needs to pass a
special resolution specifying the timeframe for buy back and maximum price at which the
buyback will be made.
As buyback of shares result in the reduction of outstanding shares, even if there is no change in
the P/L, it would result in increased EPS for post buy back shareholders. These shareholders
may also enjoy higher dividend on each of their shares. Assuming the market value of shares
based on earnings remains same pre and post buyback, as it is to be spread over smaller lot
now, market value per share goes up.
9.12 Delisting and relisting of Shares
Delisting of shares refers to the permanent removal of the shares of a company from being
listed on a stock exchange. Delisting may be compulsory or voluntary. In a compulsory delisting,
the shares are delisted on account of non-compliance to regulations and the clauses of the
listing agreement by the company. In a voluntary delisting, the company chooses to get the
shares delisted and go private. The motives may range from regulatory reporting complexities
and compliance overhead to mergers and acquisitions and sometimes to have freedom to
execute a changed strategy. Any voluntary delisting has to happen as defined in the regulations
by SEBI.
SEBI regulation, among other things, require that the promoter group provide an exit
opportunity to all shareholders. The promoter or promoter group should invite bid to acquire
the shares through a reverse book building process. Under this system, the promoter need to
specify the floor price. Shareholder’s then specify the price at which they are willing to sell the
shares.
The promoters can accept the bid price, reject the bid price (cancel the delisting plan) or
provide a counteroffer to the public. Voluntary delisting can go through only if the promoter
holding in the entity cross 90%. If that is not possible, then the company cannot delist. Further,
at least 25% of public shareholders should participate in the reverse book building.
If a company is delisted with some shares still held by the public, then such shareholder should
have the right to sell their shares to the promoters. Promoters offer to buy those shares at the
exit price within one year.
No minority shareholder can be forced to exit at the time of delisting of shares from the stock
exchanges.
A delisted share can come for relisting. SEBI through its regulations specifies the time limit post
which a company can relist its shares. As per SEBI (Delisting of Equity Shares) Regulation of
2009, a company can apply for relisting (i) five years after delisting in the case of voluntary
delisting and (ii) ten years after delisting in the case of compulsory delisting.
9.13 Share Swap
Swap, simply means, exchange of something. Accordingly, share swap means exchanging one
set of shares with another set of shares. Term share swap is often used during a merger or
acquisition of a company when acquiring company uses its own stock as cash to purchase the
business. Each shareholder of the acquired company receives a pre-determined amount of
shares from the acquiring company. Before the swap occurs each party must accurately value
its company so that a fair swap ratio can be calculated.
Sample Questions
1. When companies give new shares to their existing shareholders without any
consideration, it is known as _________.
a. Special dividend
b. Interim dividend
c. Stock dividend
d. Cash dividend
2. Companies Act requires that a company which wants to raise further capital through an
issue of shares must first offer them to the existing shareholders and such an offer of
shares is known as ______.
a. Bonus Issue
b. Rights Issue
c. Public Issue
d. Preference Issue
3. Changing the structure of share capital of a company by increasing the par value of its
shares in a defined ratio and correspondingly reducing the number of shares to maintain
the paid up/subscribed capital is known as __________.
a. Stock Split
b. Spin off
c. Share Consolidation
d. Share swap
4. Delisting of shares refers to the ________ removal of the shares of a company from being
listed on a stock exchange.
a. Permanent
b. Temporary
c. Voluntary
d. None of the above
