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Corporate Actions in fund accounting
Here's some background to fund accounting for corporate actions.
A corporate action occurs when a company changes the terms or entitlements of equity (shares) or bonds it has in issue. This post focuses on corporate actions that affect shareholders, the equity investors.
A corporate action might involve the company paying cash to the investors. Or it might involve the investors paying cash to the company. Or there might be another entity involved.
A corporate action might involve an increase or a decrease in the number of securities in issue. Or it might involve issue of a new type of security. Or it might involve replacing securities held with securities from another issuer.
A corporate action might involve the investor making a choice between alternative courses of action. Or the investor might have no choice; they must simply accept the corporate action.
Here are some examples of corporate actions.
The company wants to distribute some of the income it has earned to shareholders. It declares a dividend and pays cash to the shareholders.
The company wants to raise more capital from shareholders. It issues rights to existing shareholders that entitle the shareholders to buy more shares at a particular price.
The company does not want to raise cash or pay out cash. But it is concerned about its current share price. If the company thinks the share price is too high compared to average share prices, it can simply increase the number of shares in issue. Given that the company doesn’t raise any finance, the value of the company and therefore the market capitalization does not change. So the market price of shares will fall in proportion to the increase in the number of shares in issue.
What if the company thinks the share price is too low compared to average share prices. It can reduce the number of shares in issue and thus raise the share price.
Some corporate activity such as takeovers or mergers can mean that shares from what were two distinct entities are replaced by a share in the new combined entity.
Other corporate activity such as a spinoff can mean that shares in what was one entity are replaced by shares in two entities.
With this corporate activity there will often be cash flows involved.
Considering corporate actions from the investor’s viewpoint, it is clear that, as a result of a corporate action,
an investor might receive some cash
the number of shares held by an investor might increase or decrease
an investor might be entitled to a new type of share
an investor might have an existing holding replaced by a new holding
the market price of a share can be moved significantly as a result of a corporate action
an investor might have to make a decision
Viewing corporate actions form an investment fund perspective, corporate actions can
Change the number of shares held by the fund
Change the market price at which holdings should be valued
Entitle the fund to new shares or instruments not previously held
Extinguish an existing holding
Entitle the fund to receive cash
So the market value of securities held, or cash receivable by the fund, can be affected by corporate actions. Clearly, corporate actions must be considered in the net asset valuation process.