What is Proration?
Proration arises during specific events, often when a company splits its original cash and equity offer in line with shareholder preferences. This typically occurs during acquisitions. In instances where both cash and equity are offered, shareholders can choose their preferred form of compensation. However, if the available cash or shares can’t fully satisfy these preferences, proration ensures a fair distribution by allocating a proportionate amount of both cash and shares to each shareholder.
It’s crucial to distinguish proration from pro-rata. Proration involves adjusting the cash and equity distribution in response to shareholder choices, while pro-rata refers to a proportional allocation based on a predefined ratio.
Key Takeaways
- Proration involves splitting a company’s cash and equity offer to align with investor choices.
- It occurs due to insufficient cash or equity to fulfill all shareholders’ requests during corporate actions.
- Common scenarios include mergers, acquisitions, stock splits, and special dividends.
- Shareholders may have preferences for cash over equity based on tax implications, interest rates, and growth prospects.
- Proration is different from pro-rata, which is a predefined proportional allocation.
The Purpose of Proration
Proration helps maintain fairness during events like mergers and acquisitions by ensuring all shareholders are treated equitably. This process merits importance because it prevents favoritism and balances the distribution among all investors. Proration might be applied in other scenarios such as bankruptcies, liquidations, special dividends, stock splits, and spinoffs. These actions, generally ratified by shareholders, aim to maximize shareholder wealth while ensuring equality.
Proration in Mergers
Mergers serve diverse corporate purposes like increasing market share, cost reduction, and expanding into new markets. The new company’s shares post-merger are distributed to the existing stakeholders from both merging companies. Decisions around mergers should incorporate Federal Trade Commission’s guidelines to prevent monopolies and ensure competitive practices. It’s critical to evaluate if the merger will generate excessive market power, especially in horizontal mergers involving direct competitors.
Example of Proration
Imagine a company plans to acquire its competitor for $100 million, split into 75% cash and 25% equity. Should the shareholders predominantly prefer cash, the company would need to adjust its distribution strategy. Consequently, each shareholder might receive a reduced cash amount than initially planned to accommodate the preferences, leading to a proportional distribution of both cash and stock.
What is a Proration Factor?
The proration factor defines the fraction of equity shares accepted by the acquiring company, allowing the target company’s shareholders to engage in the takeover offer. Additionally, it can refer to the pension eligibility entitled to a plan’s participant.
Why Does Proration Happen?
Proration becomes necessary when available cash is insufficient for a planned corporate action. Equity shares replace cash as a partial or full form of payment.
Proration in Accounting
In accounting, proration involves allocating under- and over-utilized resources to balance the books at an accounting period’s end. This practice helps in accurate financial reporting and resource management.
Related Terms: pro-rata, stock splits, special dividends, stock buybacks.
