Chapter-1 Corporate Action and Its Purpose

Certificate in Corporate Action

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Certificate in Corporate Action TCS Business Domain Academy

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would tantamount to violation of confidentiality agreement signed by you while joining TCS.

Notice
The information given in this course material is merely for reference. Certain third party
terminologies or matter that may be appearing in the course are used only for contextual
identification and explanation, without an intention to infringe.
 Chapter – 1 Corporate Action and Its Purpose

Introduction
Corporate Action deals with the actions initiated by the issuer of securities which affect the
positions of the security holders in turn. This chapter tries to capture the basic idea
regarding corporate management, Board of Directors, Corporate actions basics, Purpose of
corporate action, Lifecycle of corporate action etc. At various stages examples are provided
in order to understand the concept properly.

Learning Objective
After reading this chapter you will:
• Understand what Corporate management is
• Basics related to Corporate action
• Types of corporate Actions & their purposes
• Impact of Corporate Action.

Topics Covered
Chapter – 1 Corporate Action and Its Purpose ....................................................................3
Company Management.................................................................................................... 4
1.1 Corporate Action and It’s Purpose............................................................................... 4
1.2 Impact of corporate Action ........................................................................................ 12
Summary: ....................................................................................................................... 16
Certificate in Corporate Action TCS Business Domain Academy

Company Management

On incorporation, a company becomes a legal entity. Being a legal entity, it conducts its
business with the help of representatives chosen by the shareholders. These
representatives are termed as directors. Section 2 (13) of Indian companies Act defines a
director as including “any person occupying the position of a director by whatever name
called.”

Legal status of director can be described in several ways like

• As a trustee
• As an agent
• As a managing partner.

In India, Section 252 of the companies Act specifies that a public limited company shall have
at least three directors. Companies other than a public limited company should have at
least two directors. A person can be appointed as a managing director of any number of
private companies not being subsidiaries of a public company. However , if he/she is the
managing director of a public company or a private company which is a subsidiary of a
public company, then he/she can be appointed as a managing director in only one more
company whether a public company, or private company. The board of directors may
appoint the following directors in certain exigencies:
• Appointment of any additional director
• Appointment of a Casual director
• Appointment of an alternate director.
The directors on board are supposed to perform certain duties as their position demands. If
they are not able to perform those duties then they will be liable and they can be removed
by the shareholders.

1.1 Corporate Action and It’s Purpose

A corporate action is an event in the life cycle of a security (shares or bonds), which is
affecting the position in those securities. The issuer of the securities generally initiates such
actions.
Whenever the issuer of the securities is initiating some action like
• Issuance of bonus shares

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• Issuance of dividend income to the equity or preferential share holders

• Changing the Capital Structure of the company by issue of debt or more securities
etc is called as Corporate Actions.
The grouping of corporate action events can be done based on

Issuers purpose

The impact of the corporate events based on the position holders perspective

The lifecycle of the event.

Purpose of Corporate Action

Following are various reasons for which corporate actions are initiated by the corporate.

Figure 1: Issuer Activities

Distribution of Income

This action relates to the distribution of profits to the shareholders & bondholders by the
issuer. To shareholders, the distribution will be in terms of dividends to the face value of the
share. The Board of Directors decides on how much dividend is to be issued. Dividend
payments are entirely tied to company earnings and therefore have no guaranteed
payment. The distribution of the income may occur in several forms like cash, securities or
scrip. The position holder may be offered options in which form he /she wants the dividend
payment.
Let us take an example to understand this concept.

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Suppose Mr. X is having 100 shares of TCS. The face value of one share is Rs. 10. The total
capital value held by Mr.X would be Rs. 1000. When TCS announces a dividend of 10% per
share, that means Mr. X. is going to get 10 % on the face value of the share multiplied by the
number of shares, so in this case it will be Rs. 100.
A number of possibilities of paying such dividend payment exist:
• Cash dividend
• Stock dividend
• Scrip dividend
• Optional dividend
• Dividend re-investment plan.
For the bondholders the distribution will be in terms of Coupon (interest) payments, which
is made at per stated intervals and mostly it will be fixed (varies in case of floating rate
bonds). The cash payable is based on the face value of the bond, the interest rate, and the
period for which interest relates. Every time a coupon payment is made it is termed as
corporate action.
Let us take an example to understand this.
Mr. X is holding central government bonds of Rs.1, 00,000, with a face value of Rs. 1000 and
the interest is 10 %, maturing in 2015. If the Coupon payment is paid annually, then Mr. X
will receive Rs. 10,000 annually from the Issuer (Central Government). Such interest
payments are normally tax-free.
Coupon payments are of various forms:
• Coupon Payment: - as explained above
• Coupon payment with currency option: - in this type of payment, the payment
happens in any type of currency. Here the position holder has to select the type of
currency in which he wants the payment
• Coupon payment with Capital: - When a certain portion of the principal is paid back
along with the coupon, that ultimately represents the redemption of the debt part,
such a coupon payment is known as amortized coupon.

Raising of Capital

If the issuer is in need of capital for business expansion, then issuer can issue additional
bonds and shares in addition to the existing ones. Such an issue of additional shares to
existing shareholders to augment its capital by the Issuer is also a form of Corporate Action.

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There are several ways to raise additional Capital like Issue of Rights shares; Issue of
Entitlement shares, priority or preference issue, equity call, private placements, Initial public
offers (IPO : If raised from the primary market),Follow on public offer (FPO : If raised from
the secondary market) etc.
Let us try to understand one by one.

1. Rights issue
This is an offer to subscribe to additional capital of a company to the existing shareholders
on a prorata basis at a specified price. The rights itself is typically known as ‘Nil paid right’,
and has a very short life span (2 to 6 weeks). The nil paid right is renounce-able (saleable),
meaning that the holder may sell its nil paid rights in the market, or can also purchase more
rights from the market.
Prior to the expiry of these rights issue the holder may convert this into specified security,
as per the issuers details, but in order to get the rights issue share he/she has to pay the
price specified within the stipulated time line. On payment, the holder is said to have
subscribed to the Rights Issue.
If the Holder fails to subscribe by the issue deadline, then the right would expire and after
that the person would not be eligible to buy the rights share.
Let us take an example to understand this.

Paid up equity capital (10, 00,000 shares of Rs 10 each) 10,000,000

Retained earnings 20,000,000
Earnings before interest & tax 12,000,000
Interest 2,000,000
PBT (Profit before Taxes) 10, 000,000
Taxes (50%) 5,000,000
PAT (Profit after Taxes) 5,000,000
Earnings per Share Rs 5
Market price per share Rs 40
No. of additional equity shares proposed as right 2, 00,000
Proposed subscription Price Rs 20
No. of existing shares required for a right share (1,000,000/2, 00,000) 5

Value of share

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The value of share, after the rights issues, is expected to be {(NP0+S)/(N+1)}

Where, N= number of existing shares required for a right share.
P0= market price per share
S= subscription price at which the right shares are issued
The rationale behind this formula is as follows: For every N shares before the right issue
there would be N+ 1 share after the right issue .The market value of these N+1 shares is
expected to be the market value N shares plus S, the subscription price. Applying the
formula to above data the value per share after the right issue is expected to be:
(5*40+20)/(5+1) = Rs.36.67

Value of rights
The Theoretical value of right is P0-S/N+1. The value is determined as follows.
The difference between market price of share after the rights issue and the subscription
price is the benefit derived from N rights, which are required along with the subscription
price to obtain one rights shares. This means that the values of N right is: (N P0+S/N+1) –S =
N (P0-S/N+1)
Hence the value of one right is (N P0+S/N+1)*1/N = P0-S/ N+1
Applying the above formula to the given data, we find the value of right 40-20/5+1 = Rs3.33.
The wealth of existing share holders, per se, is not affected by the rights offering,
Provided, of course, the existing shareholders exercise their rights in full or seek their rights.
To illustrate this point, consider what happens to shareholder who owns 100 equity shares
that has market value of Rs 40 each before the rights issue. The impact on his wealth when
he exercises his rights, when he sells his rights, and when he allows his rights to expire is
discussed in the ensuing paragraphs.
He exercises his rights
Market value of original shareholding at the rate of Rs. 40 per share =Rs. 4000
Additional subscription price paid for 20 rights share at the rate of Rs. 20 each =Rs 400,
Total investment =Rs. 4400, Market value of 120 shares at Rs. 36.67 per share after the
rights subscription =Rs. 4400, Change in wealth (Rs. 4400-Rs. 4400) =Rs .0
He sells his rights
Market value of original shareholding at the rate of Rs. 40 per share =Rs. 4000
Value realized from the sale of rights at Rs. 3.33 per right =Rs.333
Market value of 100 shares held after the rights issue at the rate of Rs. 36.67 per share = Rs.
3667, Change in Wealth (Rs. 3,667 + Rs. 333 – Rs. 4000) = Rs. 0

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(Is this correct logic? Value realized from sale of rights would be 20x3.33=Rs.66.60. This
implies a loss of [ (3667+66.60) - 4000] = - Rs.226.40.(Loss)
He allows his rights to expire
Market value of original shareholding at the rate of Rs. 40 per share =Rs. 4000
Market value of 100 shares held after the rights issue at the rate of
Rs. 36.67 per share =Rs. 3667, Change in Wealth (Rs. 3,667- Rs. 4000) = -Rs. (333) (Loss)
Setting the subscription price
The subscription price is irrelevant because the wealth of the shareholder who subscribes to
the right shares or sells the rights remains unchanged, irrespective of what the subscription
price is.
To illustrate this point, consider a shareholder who has N shares valued at P0 and who
enjoys the right to subscribe to an additional share for S. His total investment would be:
NP0+S.
The value of his shareholdings after subscription would be: - Numbers of shares X market
value per share after rights issue .This is equal to: (N+1) (NP0+S)/ (N+1) = NP0+S
Thus the value of its shareholding after the subscription is equal to the value of its
investment. This is irrespective of the subscription price S. In practice, however the
subscription price is important. Existing shareholders do not like the idea of S being higher
than P0 because when S is higher than P the market value after the issue would be lower
than S. NON- shareholders, who have an opportunity to subscribe to shares not taken by
existing shareholders, will have no interest in the shares if S is higher than P0 because they
would then suffer a loss when the market value fall below S after the issue. Due to the
above consideration, S has to be set equal to or lower P0. A value of S is not advisable
because it has no appeal to existing shareholders and other investors as they do not see any
opportunity of gain in such case.
2. Entitlement Issue
This is the offer of new shares to existing shareholders in proportion to their existing
holdings at a specified price. But the main difference between this and the rights issue is
that the right to subscribe is not saleable (non- transferable).
3. Priority Issue
This is the offer of a new form of security or of a holding in a new company, to both the
public and to the existing position holders in proportion to their existing holdings, at a
specified price. Existing position holders are given priority over the public. The right to
purchase is non – tradable. The security holder may or may not go for this participation.

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4. Equity Call
This is the type of increase in capital raised by paying the remaining capital by the
shareholders. This applies to only those kinds of shares where the total amount of capital
has not been fully subscribed by the position holders. They have partly paid the amount. As
and when the company is in need of money, they will make a call to the shareholders who in
turn will pay the amount as specified by the issuer. This allows the issuer to spread the
raising power over a period of time. If the shareholders are not able to pay the required
amount during the stipulated time for the final call, then the call may result in the forfeiture
of the holding for the position holder. Afterwards he will not be allowed to participate in any
kind of events related to those securities. To become shareholder again he/she has to buy or
subscribe for it again.

Restructuring of issued Capital

Depending upon the conditions the issuer may want to change the structure of the issued
capital from time to time. He can buy back the shares or split the shares, which is nothing
but restructuring of the capital.

1. Change in Security ranking

Securities issued by way of other events, such as bonus issue and rights issue, may be issued
with the different characteristics the original security is having. This event happens when
the two different types of securities issued with the different characteristics become
identical in all respect. As an example, if the person is 1000 shares of TCS. 500 additional
shares have been allotted through the bonus issue. When the issuer announces the change
in security ranking, the 500 new shares will get merge with the older ones and now the
holder will be entitled to get the dividend on 1500 shares.

2. Share split
A share split is an increase in number of shares proportional to reduction in the capital value
of each existing share. There is no change in the capital value, at the same time to the total
market value of the shareholders position at the time of split. But the market price of the
share will normally reduce proportionally to the change in the value.
Assuming Mr. X is having 100 shares of TCS with the market price of Rs.500. The face value
of the share is Rs.10. If TCS is announcing the share split of one share to two, then the
resultant face value of the share will be Rs. 5. And the total number of shares with Mr. X will

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be 200. The market price of the TCS shares will decrease accordingly. The capital value
contributed by Mr. X. will remain same as before.

3. Consolidation (Reverse Split)

A consolidation is a decrease in an issuer's number of issued shares proportional to an
increase in the capital (par) value of each existing share. The result is no change in the
capital value of the shareholder's equity or the total market value of the shareholder's
position at the time of the consolidation, nonetheless the market price per share will
increase normally (proportionally) to the change in par value. This is typically the reverse of
the share split explained above.
Assuming Mr. X is having 100 shares of the TCS with the market price of Rs.500. The face
value of the share is Rs.10. The capital value will be Rs.1000. If TCS is announcing the
consolidation of one for two, then the resultant face value of the share will be Rs.20. And
the total number of shares with Mr. X will be 50. The market price of the TCS shares will
increase accordingly. The capital value contributed by Mr. X. will remain same as before
(Rs.1000).

4. Scheme of Arrangement
This is a mix of combination for securities and the cash to the position holders. The purpose,
similar to that of a share split or consolidation, is a restructure of the issuers issued capital.

5. Capital Repayment
This is a reduction in the capital (par) value of equity, thereby reducing the position holder’s
ownership in the company. In this type of restructuring the portion of the par value is re
paid.
Assuming Mr. X is having 100 shares of TCS at the face value of Rs. 10. Now TCS decides to
pay Rs. 2 from the par value of the original capital to the shareholders. So share holders will
get the Rs. 200 in cash. The resultant face value of the share will now become Rs.8, and the
total contribution of Mr. X will now reduce from Rs.1000 to Rs. 800.

6. Buy- Back (Re purchase Offer)

It is a kind of repurchase of securities by the issuer at the published price. The price of
repurchase may be at the discount or at the premium to the face value. The events result in
reduction in share capital and payment of cash to the share holders who opt for
participation in this kind of event.

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7. Odd lot offer

This is the opportunity for the position holders with odd lot holdings, to round their
holdings into tradable lots. The rounding off is achieved by the issuer to sell more securities
to the position holders. In some cases converse also becomes true.
Let us understand this with the help of an example.
Mr. X is having 90 shares of TCS. The issuer announces that it will buy at a price of Rs.10.
each share for the lots under 100. IF in this case the position holder wants to sell the
securities than he/ she will get Rs. 900 from the issuer.
Even in case of IPOs, book building process of allotment require one to buy in a lot,& a lot
may contain ant number of securities depending upon the offer document.

8. Warrant Exercise
Warrant exercise is the opportunity for position holders to exchange their holding in
warrants to another form of security, at a fixed price, at or before pre-specified date.

1.2 Impact of corporate Action

It can be broadly divided into two types.

Impact from the position holder’s perspective
As a position holder the impact of a corporate action is measured in terms of its impact to
securities (cash) positions; consequently corporate action events can be categorized in
three different types:

Figure 2: Position Holder’s Perspective

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Benefits:
These are events that result in an increase to the position holder’s securities or cash
positions, without altering the underlying security. We can take an example of the bonus
issue. With the issuance of a bonus issue, the net impact on the shareholders wealth will be
positive as without investing anything more one would hold more securities.
Re- organizations
These are events that re-structure the position holder’s underlying securities position,
possibly also combining a cash element. We can take an example of
• Equity re-structuring which results in the exchange of security on par value
with a security of a different par value
• A conversion where one type of security such as a convertible bond is
exchanged for a different type of security, such as an ordinary share
• A subscription where one type of security such as a nil paid right is
exchanged for a different type of security such as an ordinary share, upon the
payment of a cash amount.
Issue Notices:
These events are used for the dissemination of information from the issuer to position
holders. We can take as an example for the notification of annual general meeting. This
announcement results in no change to either the securities or cash position of the position
holder.

Redemption of Debt

Upon issue of bonds the amount will appear as a liability to the issuer, where as when the
bonds are matured and the amount is being paid by the issuer, the same will be reduced
from the liability. So these kinds of actions that affect the security holders are called as
corporate action. The terms of repayment are known at the time of issue of the bond.
Typically the redemption of the bond is mandatory, but the issuer may redeem the amount
prior to the maturity provided that the clause is mentioned during the purchase of the bond.
There are several types of bond redemption like:
• Bond Redemption (Full value)
• Partial redemption
• Early redemption
• Voluntary redemption

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• Drawing.

Restructuring Debt liabilities against Issued Capital

Depending upon the conditions the issuer may want to convert the debt liabilities to the
issued capital. Such conversions will reduce the debt liabilities of the issuer and at the same
time will increase the capital in the issue.

Bond and note conversion

This is the opportunity for the position holder to exchange their holding to another form of
security (usually ordinary shares or common stock). Here the conversion of the debt
securities happens to the common stock or preferential stock. From the issuer perspective
such a conversion will result in change in the balance sheet. This could be generally stated in
the terms while purchasing the bonds. The issuers generally give option to the holders for
the conversion.

Reorganization of capital structure

1. Merger
A merger happens when the assets of the two companies are combined. Then typical result
is the exchange of securities between the two for the newly created company.
Let us take an example to understand the concept.
Suppose ABC ltd wand D ltd decides to merge their business and create a single new
company E ltd. The terms of the merger can be
• The two shares of ABC ltd. Will be replaced by the 1 share of the new
company
• The four shares of D ltd will be replaced by the 1 share of E ltd.
If Mr. X is holding 1000 shares of ABC ltd then he will get 500 new shares of E ltd.
Another position holder Mr. Y is having 1000 shares of D ltd then he will get 250 shares
of E ltd.
2. Spin -off (De-merger)
This is a kind of distribution of securities in a subsidiary to the shareholders of the parent
company without the surrender of the original underlying security.
Let us take an example to understand this.
Assuming ABC ltd decides to spin off a new company D ltd. The terms of the spin off are
• Three shares of D ltd for every one share of ABC ltd or

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• Two shares of D ltd and a cash of Rs.10.

For every share held in ABC. If Mr. X is having 100 shares of ABC ltd. Then he may
choose from the above said two options; he will either get 300 shares of D ltd or he can
have 200 shares of D ltd and Rs.1000 in cash.

3. Takeover (Acquisition)
In case of takeover, one organization takes over the control of the other organization in
order to capture the market, diversify the product range, and control the supplier or
distributor networks. These kinds of actions again affect the position holders of shares and
bonds. This is also a form of Corporate Action.
In this case the target company shareholders are given various options to choose from the
given range and depending upon their choices the acquirer company fulfills the
requirements.

Information dissemination to share holders

Issuer meetings with proxy voting

The company management is obliged to the inform share holders regarding the various
activities that affect the operation and profitability of the company, and in some cases will
also need to seek the shareholders approval of such activity before it is being done. This is
kind of notification to the position holders for the company meeting. There are different
types of it like Annual general meeting (AGM), extraordinary general meeting (EGM). This
type of event applies to all position holders but not make any impact to the position
holder’s securities.

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Summary:

• Directors are representatives of the shareholders who in turn take decisions on

behalf of them for the company.
• A corporate action is an event in the life cycle of a security (shares or bonds), which
is affecting the position in those securities.
• The grouping of corporate action events can be done based on Issuers purpose, the
impact of the corporate events based on the position holder’s perspective, the
lifecycle of the event.
• Impact of corporate action can be divided in two types :
• Impact from position holders perspective
• Impact of the price of the underlying security.

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