Bonus Issue Uncovered: Insights, Analysis, and Perspectives

Bonus issue is a corporate action taken by a company to offer extra shares to the existing shareholders which is an alternative of dividend payout. When additional shares are issued to the shareholders, there is an increase in the number of shares but the value of investment doesn’t change. A company that announces this kind of corporate activity represents that it is expanding equity and liquidity. Issuing the bonus-shares increases the share capital of a company but does not increase its net assets. It can help the shareholders to meet liquidity requirements by selling their extra shares.

What is the bonus issue?

Bonus Issue is a corporate activity undertaken by a company wherein the company announces to offer extra shares to its existing shareholders. The strategy is adopted by a company to reward shareholders and maintain their trust towards the company’s operations. Under this activity, bonus-shares are allotted that affect the number of shares in an investor’s portfolio without making an impact on market capitalization as the price per share is adjusted to maintain the liquidity. Thus, it builds the reputation of the company in the eyes of investors.

What are bonus shares?

When the company issues an additional number of shares to its existing shareholders as a means of distributing gains from business and are referred as a ‘bonus’. A company can issue bonus shares instead of paying dividends to the shareholders. The bonus shares are also known as bonus-issue, scrip issues, or capitalization issues.

For example: If you are holding 100 shares of a company XYZ and it has announced to issue a 4:1 bonus which means that you will receive four extra shares for each share held in your portfolio. You will get 400 shares for those 100 shares but your investment will remain the same. The total number of shares would be 500.

Types of Bonus Shares

Companies issue extra shares for several reasons and form strategies as per the requirements of the company. As per the strategy adopted by a company, it may issue two types of shares which are fully paid and partly-paid.

Fully Paid Issue

Fully Paid Shares are the shares distributed to the existing shareholders and are free of charge. A company can issue fully paid bonus shares by capitalizing its reserves, capital redemption reserves, profit and loss account and security premium account.

Partly Paid Issue

Partly-paid shares have to be purchased by the investors without paying the total issue price upfront. Shareholders are required to make certain payments in order to fully own the extra shares distributed by the company. Investors can make the payment in installments when the company issues a call.

Cash Bonus Issue

When the bonus shares are paid from the company’s earnings to the shareholders as a reward, this process is known as cash bonus issue. Cash bonus issues can be done in the form of special dividends, or by directly distributing cash to the shareholders.

Stock Bonus Issue

Stock bonus issue is directly related to the increase in ownership of the stakeholders. Stock bonus issue refers to the process when a company distributes additional shares to the shareholders, hence diluting the ownership of the company.

Eligibility Criteria

Shareholders who already hold the stocks of the company before the record date and the ex-date as per company’s policies are eligible to get the shares. Record date is a date set by the company which specifies the date that a shareholder must have held the shares from a particular date to be eligible to get the shares. The ex-date is two days after the record date. So, the investors must buy the shares of the company before the expiry date because once the ISIN number is allotted to the shareholders, the shares get credited in their account within the next 15 working days.

Why does a company issue bonus shares?

A company may issue bonus shares to encourage participation of retail investors in the stock and adding liquidity to the shares by reducing the prices of shares after the issue process. The motive behind this activity can be to gain the trust of existing shareholders and enhance the company’s image among investors. Moreover, this can be done to manage market liquidity as to increase the availability of a number of shares. Also, the company focuses on increasing its accessibility to a wide range of investors without making an impact over market capitalization. There are key several other reasons:

To encourage participation of retail investors

After the issue of additional shares by a company, the price of shares gets reduced encouraging retail investors to increase their participation in the asset as it becomes affordable. Many retail investors do not take part in the stock if it is quite expensive, extra shares in the market increase the liquidity because of reduced share prices. Retail investors are hence encouraged to buy or sell the shares in the market quickly.

Display sound financial health

Bonus shares are issued by a company out of profits or reserves which represents a company’s strong financial health. Investors positively interpret this corporate activity and expect future profitability and growth of the company. Hence, it displays that a company has sufficient reserves to reward shareholders.

Positive Psychological Impact

A positive impact is created in the market as it determines the company has extra reserves. It creates a positive perception of the stock in the eyes of existing as well as new investors.

What are the benefits of bonus issues to the shareholders?

Shareholders can enjoy multiple benefits by issue of bonus-shares and have improved investment strategies and financial goals. Investors can gain financial benefits as well as psychological benefits through bonus issues. Shareholders can receive a large amount of dividend if in future the company decides to declare a dividend on the shares allotted. Moreover, the confidence of shareholders has increased in the company’s future prospects.

Tax Benefits

Investors or shareholders can enjoy tax benefits as they are not required to pay any tax when they receive extra shares from a company. Investors are not eligible to pay tax on bonus-shares while they are obligated to do so when they receive dividends. Investors have to pay 30% tax on the dividend received by them while in case of bonus-issue they have to pay tax on capital gains as per Indian tax regimes which can be 10% to 15%.

Ownership Stake

Shareholders have an increased ownership stake in the company as they have more number of shares after issuing of shares by the company. The shares of investors are increased without investing more capital. The ownership stake of shareholders is proportionally increased to the number of additional shares received by them from the company.

Lower Average Cost

The average cost of capital invested is reduced because the shares are rewarded at no cost to the shareholders. Investors can enjoy potential gains if the price of the shares appreciates in future as the average price of investment is reduced.

Affordability and Accessibility

New investors are attracted towards the company as the price of its shares gets reduced. Issuing bonus-shares makes it affordable for new investors to invest and quickly accessible to them. Investors can also exit their position with an immediate effect as per their formed strategies.

Disadvantages of Bonus Shares

Apart from benefits, bonus-issues can turn out to be risky for investors and companies as well. Shareholders have to analyze the risks associated and negatives when a company makes a decision to increase liquidity in the market. 

For Investors

Issuance of extra shares results in increasing the number of shares held by the investors which dilutes the earnings per share. Reduced earnings per share affect the valuation in a negative way because the profits don’t get changed. Earnings per share for shareholders are decreased despite an increase in the number of shares.

For Company

The company has a disadvantage of issuing additional shares as it limits the capacity for a company to reduce its debts and invest in new projects. Also, the company reduces its flexibility to raise capital in future because of the distribution of a large number of shares. Issuing shares also suggests that the company has a lack of sufficient cash to pay a dividend. Moreover, the cost associated with this is burdensome.

Dilution of Ownership: Issuing bonus-shares means that the company is diluting its ownership to the shareholders in the form of bonus share which indicates that the company might face difficulties in raising capital in future which is why dilution of ownership is a disadvantage for a company.

Conclusion

The blog sums up that bonus shares are issued by a company in place of dividends which signifies sound financial health of the business to the investors. Issuing bonus shares has its potential advantages and disadvantages which should be understood to make future predictions about a company’s growth.

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