What are bonus shares? Why do companies issue them?

What Are Bonus Shares?  

Bonus shares are additional shares distributed by a company to its existing shareholders without any cost, based on the number of shares they already own. When a company issues bonus shares, it's essentially distributing its accumulated profits or reserves to its shareholders in the form of additional stock rather than cash dividends.

For example, if a company announces a 1:1 bonus issue, shareholders will receive one additional share for every share they already own. This means that if you held 100 shares before the bonus issue, you would now have 200 shares. However, it's important to note that while the number of shares increases, the overall value of your holding remains the same, as the stock price adjusts proportionately.

Types of Bonus Shares

There are primarily two types of bonus shares that companies can issue:

1. Fully Paid Bonus Shares: These are shares given to shareholders without any additional payment required. They are issued by converting a portion of the company's free reserves into capital.

2. Partly Paid Bonus Shares: These are shares that are issued partly paid up. Shareholders may be required to pay the remaining balance in the future when the company decides to call it. Partly paid shares are less common as bonus shares because they require future payments from shareholders.

Why Do Companies Issue Bonus Shares?

Companies issue bonus shares for several reasons, including the following:

1. Improving Liquidity: By increasing the number of shares in circulation, companies can improve the stock's liquidity, making it easier to trade.

2. Signaling Financial Health: Issuing bonus shares can signal a company's strong financial position, indicating sufficient retained earnings to support such distribution.

3. Attracting New Investors: A reduced share price post-bonus issue can make shares more affordable, attracting new investors and increasing market participation.

4. Rewarding Shareholders: Bonus shares serve as a reward to existing shareholders, providing them with additional equity in the company without any cost.

5. Adjust Share Price:

Issuing bonus shares reduces a company's share price, making it more accessible for small investors and encouraging broader market participation.

6. Aligning with Market Expectations: Some companies issue bonus shares to align with market trends and expectations, maintaining investor confidence and satisfaction.

Advantages of Bonus Shares for Shareholders

1. Increased Shareholding: Shareholders gain extra shares, enhancing their ownership in the company without needing to make any additional investments.  

2. No Cash Outflow: Bonus shares are distributed to shareholders without any cash expenditure, enabling them to increase their holdings at no cost.

3. Market Perception: The issuance of bonus shares often signals a company's strong financial position, which can boost investor confidence.

4. Tax Efficiency: Bonus shares are often not taxed at issuance, allowing shareholders to defer tax liabilities until they sell the shares.

Advantages of Bonus Shares for Companies

1. Improved Liquidity: Increasing the number of shares can enhance stock liquidity, making it more attractive to investors.

2. Strengthening Shareholder Loyalty: Rewarding shareholders with bonus shares can increase loyalty and commitment to the company.

3. Maintaining Competitive Edge: Issuing bonus shares can keep investor interest high and maintain competitiveness in the market.

4. Utilizing Retained Earnings: Companies can capitalize on their reserves, showcasing financial strength by issuing bonus shares.

Disadvantages of Bonus Shares for Shareholders

1. Dilution of Share Value: The value of each share may decrease as the number of shares increases, potentially affecting market perception.

2. No Immediate Cash Benefit: Unlike dividends, bonus shares do not provide an immediate cash benefit to shareholders.

3. Potential Misinterpretation: If not communicated well, bonus shares might be seen as a sign of financial distress rather than success.

4. Delayed Earnings Realization: Shareholders may have to wait for the market to recognize the value of their increased holdings.

Disadvantages of Bonus Shares for Companies

1. Dilution of Earnings: The increase in shares can dilute earnings per share (EPS), affecting the company's perceived profitability.

2. Increased Administrative Costs: Issuing bonus shares involves administrative expenses and compliance requirements.

3. Complex Financial Communication: Companies must clearly explain the rationale for issuing bonus shares to avoid misunderstandings.

4. Potential for Stock Overhang: An excess of shares in the market might lead to reduced share price appreciation.

FAQs

1. Who is eligible for bonus shares?

Shareholders who hold the company's stock on the record date qualify for bonus shares. The record date is set by the company and determines who receives the bonus shares.

2. Is a bonus share good or bad?

Bonus shares can be good as they increase shareholder value and liquidity, but they may also dilute the share price. It depends on the company's overall performance and market perception.

3. What is a bonus issue of shares?

A bonus issue is the distribution of additional shares to existing shareholders at no extra cost, typically done by capitalizing reserves.

4. What is the Record Date?

The record date is the date set by the company to determine which shareholders are eligible for bonus shares. Those who own shares on this date are entitled to receive the bonus shares.

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