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A split share corporation is a corporation that exists for a defined period of time to transform the risk and investment return (capital gains, dividends, and possibly also profits from the writing of covered options) of a basket of shares of conventional dividend-paying corporations into the risk and return of the two or more classes of publicly traded shares in the split share corporation.
Most commonly a split share corporation issues equal numbers of shares from a class of preferred shares and a class of capital or class A shares. The proceeds of the share offering are invested in conventional dividend-paying shares according to the regulations of the split share corporation. The preferred shares typically offer relatively high and secure dividend yield at a fixed coupon rate but with no expectation of capital gain by the time that the split share corporation is wound up. The capital shares often (but not in every corporation) pay a dividend like the preferred shares; in addition, the capital shares offer participation in the leveraged capital gains (or losses) of the underlying basket of conventional shares.
The total market value of the shares of the split share corporation is backed by the value of the underlying basket of shares. The value of the preferred shares is further reinforced by the priority given to those shares over the capital shares in the payment of dividend income and in the eventual return of the full initial price of the preferred shares.
The underlying basket of shares may include shares from only one conventional corporation (e.g. one large-cap bank or insurance company); however, greater diversification, and usually lowered risk, is afforded if the basket contains shares from many corporations in the same sector (e.g. financial services) or across different sectors. The composition of the underlying basket of shares could be relatively fixed, that is, managed passively as in an exchange-traded fund; however, it is usually the case that the managers of the split share corporation have some flexibility to actively manage the relative proportions of the holdings within the basket in an attempt to increase the return.
The preferred and capital shares of the split corporation are issued in some fixed ratio. Often the preferred and capital shares are issued in precisely equal numbers. In such a case, each pair of preferred and capital shares is sometimes called a unit. However, the proportion of preferred and capital shares does not necessarily have to be one-to-one. Reducing the ratio of issued preferred shares to capital shares (e.g., one preferred share for every two capital shares) would reduce the risk and safely support higher yield for the preferred shares at the cost of making the capital shares less attractive to investors due to increased risk, lower sustainable yield payout and smaller capital gain leverage.
The dividend income from the underlying shares may be insufficient to pay out the dividend income for both the preferred and capital shares. In order to produce more income, split share corporations will sometimes employ covered call writing and cash-covered put writing.
As of June 2022, there are 23 split share corporations on the Toronto Stock Exchange. [1] Back in April 2013 there were 34 split share, [2] and in March 2008 there were 63 split share corporations.
The preferred shares of a split share corporation are intended to provide an investment vehicle for more conservative investors, one that provides a relatively high income stream and safety in the original investment that is secured by the value of the underlying basket of shares. Greater safety is provided since the preferred shares are given priority over the capital shares both when income is paid out and when the corporation is wrapped up. The income from the preferred shares is usually declared as dividend income, which in some jurisdictions (e.g. Canada) has favorable tax rates compared to the tax rates that apply to the interest income that is produced by bonds or commercial paper. The preferred shares of a split share corporation can offer greater diversification than the preferred shares of a single conventional corporation.
With their fixed maturity date, fixed dividend rate and seniority over common stock, the preferred shares have many of the characteristics of a bond, and thus one might expect their value on the secondary market to vary inversely with the prevailing interest rates, just like a bond. Historically, however, the values of the preferred shares of financially sound split share corporations have tended to keep relatively close to their respective wind-up values. In practice credit risk appears to be a greater factor in the valuation of the relatively thinly traded preferred shares as opposed to the value of alternative (and more efficiently traded) conventional fixed-income instruments like bonds.
The capital shares of a split share corporation are intended to be a more aggressive investment vehicle, one that can provide both high income and the promise of amplified capital gains compared to the capital gains of the underlying basket of shares. In effect, the holders of capital shares are borrowing money from the holders of the preferred shares at the dividend rate of the preferred shares, and investing that money in a greater number of shares in the underlying basket of shares. Capital gains (or losses) are amplified in the capital shares because the value of the preferred shares is held relatively constant, and the resulting increased volatility of the equity in the underlying basket of shares is borne mostly by the capital shares. Holders of the capital shares take on their obligation to guarantee dividend payments to the holders of the preferred shares in exchange for amplified returns. In addition, the income from the capital shares can be structured to be treatable, for tax purposes, as mostly or even entirely capital gain. In many jurisdictions, such as Canada, capital gains are taxed at a lower rate than either dividend income or interest income.
The capital shares bear greater risk than the preferred shares in the event that the value of the underlying basket of conventional shares falls in value. Dividend payments to the holders of capital shares may be reduced or even suspended entirely before reductions can be considered in the dividends paid to the holders of the preferred shares. The value of the capital shares on the secondary markets may fluctuate considerably and may be reduced to zero. Over the longer term, the risk to the holders of capital shares should be moderated by the usually high quality of the underlying dividend-paying shares, typically blue-chip, in the basket.
The preferred and capital shares of a split share corporation are independently tradeable securities, and hence their value is subject to market forces. If the volume of traded shares is relatively small, then the price of split share corporations can be volatile as with any other thinly traded security. Close to the expiration date, however, the value of the preferred shares will tend to converge on the initial issue price if the split share corporation is judged by the market to have sufficient equity to fully pay back the preferred shareholders.
Some split share corporations provide an exchange mechanism, in which units of the split share corporation can be converted into shares of the underlying basket of shares, and vice versa. This mechanism would allow arbitrage trading to keep the aggregate value of the units close to the value of the underlying basket of shares, hence reducing the tracking error between the market value of the underlying shares and the risk-adjusted present value of the preferred and capital shares.
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-invested in the business. The current year profit as well as the retained earnings of previous years are available for distribution; a corporation is usually prohibited from paying a dividend out of its capital. Distribution to shareholders may be in cash or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or by share repurchase. In some cases, the distribution may be of assets.
Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, e.g., retail, corporate, investment banking, etc. In other words, financial capital is internal retained earnings generated by the entity or funds provided by lenders to businesses in order to purchase real capital equipment or services for producing new goods and/or services.
Investment is traditionally defined as the "commitment of resources to achieve later benefits". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditure and receipts are defined in terms of money, then the net monetary receipt in a time period is termed as cash flow, while money received in a series of several time periods is termed as cash flow stream. Investment science is the application of scientific tools for investments.
In finance, a warrant is a security that entitles the holder to buy or sell stock, typically the stock of the issuing company, at a fixed price called the exercise price.
In finance, an equity derivative is a class of derivatives whose value is at least partly derived from one or more underlying equity securities. Options and futures are by far the most common equity derivatives, however there are many other types of equity derivatives that are actively traded.
A perpetuity is an annuity that has no end, or a stream of cash payments that continues forever. There are few actual perpetuities in existence. For example, the United Kingdom (UK) government issued them in the past; these were known as consols and were all finally redeemed in 2015.
In finance, a convertible bond or convertible note or convertible debt is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features. It originated in the mid-19th century, and was used by early speculators such as Jacob Little and Daniel Drew to counter market cornering.
In finance, a swap is an agreement between two counterparties to exchange financial instruments, cashflows, or payments for a certain time. The instruments can be almost anything but most swaps involve cash based on a notional principal amount.
Preferred stock is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferred stocks are senior to common stock but subordinate to bonds in terms of claim and may have priority over common stock in the payment of dividends and upon liquidation. Terms of the preferred stock are described in the issuing company's articles of association or articles of incorporation.
An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the day on stock exchanges whereas mutual funds are bought and sold from the issuer based on their price at day's end. ETFs can hold assets such as stocks, bonds, currencies, futures contracts, and/or commodities such as gold bars, and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value, although deviations can occasionally occur. Most ETFs are index funds: that is, they hold the same securities in the same proportions as a certain stock market index or bond market index. The most popular ETFs in the U.S. replicate the S&P 500, the total market index, the NASDAQ-100 index, the price of gold, the "growth" stocks in the Russell 1000 Index, or the index of the largest technology companies. The list of assets that each ETF owns, as well as their weightings, is posted on the website of the issuer daily, or quarterly in the case of active non-transparent ETFs. The largest ETFs have annual fees of 0.03% of the amount invested, or even lower, although specialty ETFs can have annual fees of 1% or more of the amount invested. These fees are paid to the ETF issuer out of dividends received from the underlying holdings or from selling assets.
Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the principal amount on maturity. Fixed-income securities — more commonly known as bonds — can be contrasted with equity securities – often referred to as stocks and shares – that create no obligation to pay dividends or any other form of income. Bonds carry a level of legal protections for investors that equity securities do not — in the event of a bankruptcy, bond holders would be repaid after liquidation of assets, whereas shareholders with stock often receive nothing.
An investment trust is a form of investment fund found mostly in the United Kingdom and Japan. Investment trusts are constituted as public limited companies and are therefore closed ended since the fund managers cannot redeem or create shares.
A convertible security is a financial instrument whose holder has the right to convert it into another security of the same issuer. Most convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted into shares of the issuer's common stock. Convertible securities typically include other embedded options, such as call or put options. Consequently, determining the value of convertible securities can be a complex exercise. The complex valuation issue may attract specialized professional investors, including arbitrageurs and hedge funds who try to exploit disparities in the relationship between the price of the convertible security and the underlying common stock.
Hybrid securities are a broad group of securities that combine the characteristics of the two broader groups of securities, debt and equity.
A stock fund, or equity fund, is a fund that invests in stocks, also called equity securities. Stock funds can be contrasted with bond funds and money funds. Fund assets are typically mainly in stock, with some amount of cash, which is generally quite small, as opposed to bonds, notes, or other securities. This may be a mutual fund or exchange-traded fund. The objective of an equity fund is long-term growth through capital gains, although historically dividends have also been an important source of total return. Specific equity funds may focus on a certain sector of the market or may be geared toward a certain level of risk.
In finance, an option is a contract which conveys to its owner, the holder, the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option. Options are typically acquired by purchase, as a form of compensation, or as part of a complex financial transaction. Thus, they are also a form of asset and have a valuation that may depend on a complex relationship between underlying asset price, time until expiration, market volatility, the risk-free rate of interest, and the strike price of the option. Options may be traded between private parties in over-the-counter (OTC) transactions, or they may be exchange-traded in live, public markets in the form of standardized contracts.
A reverse convertible security or convertible security is a short-term note linked to an underlying stock. The security offers a steady stream of income due to the payment of a high coupon rate. In addition, at maturity the owner will receive either 100% of the par value or, if the stock value falls, a predetermined number of shares of the underlying stock. In the context of structured product, a reverse convertible can be linked to an equity index or a basket of indices. In such case, the capital repayment at maturity is cash settled, either 100% of principal, or less if the underlying index falls conditional on barrier is hit in the case of barrier reverse convertibles.
An exchange-traded note (ETN) is a senior, unsecured, unsubordinated debt security issued by an underwriting bank. Similar to other debt securities, ETNs have a maturity date and are backed only by the credit of the issuer.
In finance, stock consist of all the shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporation in proportion to the total number of shares. This typically entitles the shareholder (stockholder) to that fraction of the company's earnings, proceeds from liquidation of assets, or voting power, often dividing these up in proportion to the amount of money each stockholder has invested. Not all stock is necessarily equal, as certain classes of stock may be issued for example without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders.
The following outline is provided as an overview of and topical guide to corporate finance: