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Morningstar Indexes Corporate Actions Methodology

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Morningstar Indexes Corporate Actions Methodology ? Morningstar Indexes Corporate Actions Methodology Morningstar Indexes Introduction May 2016 Corporate Actions and Adjustments To understand the operational and maintenance aspects of an index, it is imperative to know how Contents adjustments are made for different kinds of corporate actions and index weighting schemes. This document outlines corporate action policy followed for Morningstar Equity Indexes in a consistent and 1 Introduction 1 Cash Distribution transparent manner. 2 Rights Offering 3 Spin-Off Cash Distribution 3 Share Adjustments and Free Float Factors Updates Cash Dividend or Ordinary Cash Dividend is a distribution of a portion of a company's earnings to its 4 Mergers & Acquisitions (M&A) shareholders at regular intervals, typically on a quarterly, semiannual, or annual basis, and quoted in per 6 Splits and Reverse Splits 6 Stock Distribution share amounts. For index calculation, it is not treated as a corporate action and thus affects total returns 7 Bankruptcy and Financial Distress and net returns but not price returns. 7 Delisting 7 Stock Suspension 8 Rebalancing Special Dividend is a nonrecurring cash distribution of a company’s earnings or assets to shareholders 8 Exchange Closures and is treated as a corporate action with price and divisor adjustments. For index calculation, the price 8 Late Announcements of the day before the ex-date is adjusted for the special dividend and thus affects all three variants of indexes. Capital Repayment is a distribution of cash to shareholders from a company’s share capital or additional paid-in capital. It is generally non-recurrent and is treated like a special dividend. Exhibit 1 Capital Repayment Categories Corporate Action Divisor Change Special Dividend Yes Capital Repayment Yes Source: Morningstar. Page 2 of 9 Morningstar Indexes Corporate Actions Methodology | May 2016 Page 2 of 9 Rights Offering In a rights issue, shareholders of a company are issued rights to buy a specified number of additional shares at a specified price, generally at a discount (in the money) within a fixed subscription period. The right to additional shares is usually proportional to the number of shares held. Exhibit 2 Rights Offering Categories Corporate Action Divisor Change Rights to Acquire New Underlying Shares Yes Rights to Acquire Other Asset 1 Yes Source: Morningstar. This treatment is applicable if the rights issue is in the money on T-1, or the trading day before the ex- date. However, there might be situations that require special treatments, which are summarized below: × When the subscription price is known only after the ex-date, the share adjustment is made after the end of the subscription period (only if the rights are in the money when the terms are disclosed). × When the new shares are not entitled to the forthcoming dividend: × If the subscription price ≥ (market price – dividend), the subscription is considered at a premium, and thus no adjustment is made. × If the subscription price < (market price – dividend), the subscription price is considered at a discount, and an adjustment is made. Treatment for Equal-Weighted and Alternatively-Weighted Indexes A rights issue is treated as a market-capitalization-neutral event, i.e., the change in the weight of the company is neutralized by applying an adjustment factor. The index divisor remains unchanged. 1 The price is adjusted only if the value of the other asset is recognized. © 2016 Morningstar, Inc. All rights reserved. Morningstar and the Morningstar logo are either trademarks or service marks of Morningstar, Inc. Page 3 of 9 Morningstar Indexes Corporate Actions Methodology | May 2016 Page 3 of 9 Spin-Off When a parent company sells a business or division, this results in an independent company known as a spun-off entity. A spin-off is also called a demerger or divestiture. Spin-offs can be categorized as follows: Exhibit 3 Spin-Off Categories Corporate Action Treatment Divisor Change Spun-off entity is trading before the Zero price spin-offs2 treatment is not used. Yes ex-date The price adjustment to the parent is calculated as the (price of the spin- off) * (spin-off ratio). Spun-off entity starts trading on 1. Spun-off entity is added to the index at a price of zero with no or after the ex-date accompanying change in the parent or divisor at this time. 2. It is removed from the index after at least one day of trading at the last Yes traded price and appropriate divisor adjustment is made. The price adjustment to the parent is calculated as the (price of the spin- off) * (spin-off ratio). Source: Morningstar. The spun-off entity is not added to the index, and its weight is distributed proportionately across the rest of the index constituents. Treatment for Equal-Weighted and Alternatively-Weighted Indexes Spin-off is treated as a market-capitalization-neutral event, i.e., the change in the weight of the company is neutralized by applying an adjustment factor. The index divisor remains unchanged. Share Adjustments and Free Float Factor Updates The share and the free float factor is updated if the change for either is in excess of 5% and depending on the nature of underlying event, availability of data and the local market practices. Changes due to tender offers, secondary public offerings, Dutch auctions, exchange offers, bought deal equity offerings, or prospectus offerings are made within a reasonable time frame, once the event details are verified. Other updates are made weekly to handle corporate events such as private placements, redemptions, exercise of options, warrants, notes, debt, equity participations, at-the-market stock offerings, voluntary buybacks, U.K. open offers, follow-up on renounceable rights offers, debt/equity conversion, tender offers, or any other update that may result in a change of shares and free float factors in excess of 5%. 2 Zero price spin-offs: The spun-off entity is added to all indexes of which the parent is a constituent, at a zero price at the market close of the day before the ex-date. There is no accompanying divisor change at this time. © 2016 Morningstar, Inc. All rights reserved. Morningstar and the Morningstar logo are either trademarks or service marks of Morningstar, Inc. Page 4 of 9 Morningstar Indexes Corporate Actions Methodology | May 2016 Page 4 of 9 Share and float factor changes of less than 5% are accumulated and implemented at the quarterly rebalance effective date, i.e., on first business day after the third Friday of March, June, September, and December. Special Treatment × If a 5% or more change in company shares results in a free float factor change of 5% or more, the new free float factor is implemented simultaneously with the share change. × When shares outstanding increase by more than 5%, but the new share issuance is directed to a strategic shareholder resulting in no change in float-adjusted shares, a shares outstanding and resulting float factor update will be made regardless of the size of the change. Treatment for Equal-Weighted and Alternatively-Weighted Indexes The above events are treated as a market-capitalization-neutral event, i.e., the change in the weight of the company is neutralized by applying an adjustment factor. The index divisor remains unchanged. Mergers and Acquisitions (M&A) In a merger, two or more companies join together to form a new entity. This is generally done by a mutual agreement or through a tender offer that can be structured in a wide variety of ways that involve cash, stock, or a combination of both. If two or more companies are in the same index, one company is identified as the target company and is deleted from the index. The acquirer may undergo a share, free float factor, or name change, depending on the terms of the agreement. In an acquisition, a company buys most or all of the target company and assumes controlling interest. The acquisition could be funded through cash, stock, or a combination of both. An acquisition will result in the deletion of the target company, and the share and free float factor of the acquirer is changed, depending on the terms of the agreement. The M&A events can be categorized as follows: × Target company is in the index and the acquiring company is not. × Target company is not in the index, but the acquiring company is. × Target and acquiring companies are both in the index. © 2016 Morningstar, Inc. All rights reserved. Morningstar and the Morningstar logo are either trademarks or service marks of Morningstar, Inc. Page 5 of 9 Morningstar Indexes Corporate Actions Methodology | May 2016 Page 5 of 9 Exhibit 4 M&A Events Categories Corporate Action Details Divisor Change Merger Implementation is determined on a case-by-case basis Yes An acquisition is funded by cash Only acquiring company is in the index No • Target company is dropped Only target company is in the index Yes • No change is made to the acquirer Both acquiring company and target company are in the index Yes An acquisition is funded by stock or stock and cash Only acquiring company is in the index Yes • Target company is dropped Only target company is in the index Yes • Share change and a possible free float factor Both acquiring company and target company are in the index Yes change is made for the acquirer Source: Morningstar. The target company is typically dropped at the closing price of the stock on the date of deletion, with the deal price being used in certain markets. There might be situations that require special treatment, as follows: × When an index constituent acquires another index constituent and the delisting of the target company is a few days before the acquisition effective date, adjustments for the acquirer would, typically, be made effective the same date as the deletion date.
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