Bonus shares are additional shares given by the company to existing shareholders, free of cost. Shareholders can transact these shares in the secondary market to meet liquidity requirements.
There are certain situations when a company is unable to pay dividend in cash, because of a possible shortage of liquid funds, despite having a profitable turnover. In such cases, the company issues bonus shares to the current shareholders instead of paying the dividend in cash. Bonus shares are issued as new or additional shares, free of cost and in proportion to the shares and dividends held by the shareholder.
Companies often issue bonus shares, even if they do not face a shortage of liquid funds. This is a strategy employed by certain companies to avoid the highly levied Dividend Distribution tax, which has to be paid when declaring dividends.
When the company issues bonus shares, since the profits or reserves of the company are converted into share capital, there is a ‘capitalisation’ of the profits. The company cannot charge the shareholders for the issue of the bonus shares. A sum that is equal to the value of the bonus issue, is adjusted against the profits or the reserve, and then transferred to the Equity Share Capital Account.
What is a bonus issue?
The term bonus issue or a bonus share issue is used to define an issue of bonus shares. The number of shares held by a shareholder is what a bonus issue is based on. Zero cash payments ensure that the position of liquidity remains unchanged.
It is important to note that the dividend per share drops since there is an increase in the total number of shares as a result of a bonus issue. This does not directly affect the value or capital of the company overall. Unlike in the case of Rights Issues, this does not dilute the shareholder’s investment. The value of the investment remains unaltered because, even though there is a decrease in the income per share, the shareholder owns a larger number of shares. The primary purpose of the issue of bonus shares is to equate the excess of assets over liabilities with the Nominal Share Capital.
A bonus issue is an assurance that the company will be able to service its larger equity. This means that the company would not have issued bonus shares if it could not guarantee an increase in profits from the shares and a distribution of dividends in the future. Therefore, a bonus issue also promotes company goodwill.
Companies issue bonus shares following constant ratio formula that allows a fixed number of shares to each shareholder based on the number of outstanding shares. Let’s try to understand what bonus shares mean with the help of an example.
Let’s say you hold 200 shares of company XYZ. Now the company issued bonus shares at the ratio of 4:1, which means four bonus shares for each share you have. Accordingly, you become entitled to 800 bonus shares for the 200 shares you have.
Who is eligible for bonus shares?
Shareholders who own shares of the company prior to the record date and the ex-date set by the company are eligible for bonus shares. India follows the T+2 rolling system for the delivery of shares, wherein the ex-date is two days ahead of the record date. Shares must be bought before the ex-date because, if an investor purchases the shares on the ex-date, they will not be credited with the ownership of given shares by the set record date and therefore, will not be eligible for the bonus shares.
Once a new ISIN (International Securities Identification Number) is allotted for the bonus shares, the bonus shares are credited to the shareholders’ accounts within a fifteen-day period.
What is the 'Record Date'?
A cut-off date set by a company is known as the record date. Investors must be owners of shares in the company by this date for them to be eligible to receive a distribution. The record date is established so that a company can identify the eligible shareholders and send them their due distributions.
Guidelines to be followed by a company before issuing bonus shares
1. The Articles of Association must sanction a bonus issue before bonus shares can be issued. If the Articles of Association is unable to do so, the company must pass a special resolution act at their general meeting
2. In case of a general meeting, the bonus issue has to be sanctioned by the shareholders as well
3. SEBI-issued guidelines must be followed
4. The company must ensure the total share capital does not exceed the authorised share capital as a result of a bonus issue. In case of such a situation, the capital clause in the Memorandum of Association must be amended by increasing the authorised capital
5. If the company has taken loans, the financial institution(s) involved must be previously informed
6. Prior to a bonus issue, a company must notify the Reserve Bank and avail its consent
7. Bonus shares that are to be issued must be fully paid. If shares are partially paid, it will make the shareholders liable to pay the uncalled amount
Advantages And Disadvantages Of Bonus Shares
After having a clear idea of what is bonus shares, let’s consider the pros and cons of bonus shares.
We have already said, companies issue bonus shares when it is cash strapped. Besides that, bonus shares increase the issued share capital of the company, making it look like an attractive option to investors.
On the market side, bonus shares provide additional income to shareholders. Shares issued in lieu of dividend is a compensation for the shareholders. Further, additional shares in the market lower the price per share, making it affordable to more investors.
On the con side, issuing bonus shares is costlier than declaring the dividend. It uses the company’s capital reserve. The corporate, on the other hand, receives no income from the release of bonus shares.
Additional shares reduce income per share, which might disappoint investors, making the stocks less attractive. They may try to sell the additional shares to meet liquidity needs, which would lower their percentage in the company.
How Bonus Share Is Different From Stock Split
A stock split is another way for companies to increase the number of shares trading in the market. Although both sound similar but stock split and bonus shares aren’t quite the same. Stock split allows companies to increase share liquidity but involves no cost. And hence, the company’s cash reserve remains intact. Bonus shares, however, are paid out from the capital reserve.
Bonus shares meaning allotting additional free shares to existing shareholders to meet their liquidity requirements. Unlike issuing fresh shares, bonus shares don’t add to the company’s earning.
What is the benefit of issuing bonus shares?
Companies issue bonus shares to increase the number of equity shares in the market. It makes the company look attractive to investors and make shares affordable to investors by lowering sgare price.
How bonus shares will be credited?
bonus shares are additional shares allotted free of cost to shareholders. companies reserve a portion of their profit, a part not paid as dividend, over the years and when the free reserve grows to a substantial volume, they release bonus shares from that.
What happens to share price when bonus shares are issued?
Is dividend paid on bonus shares? Is bonus share good for investors?
Bonus shares are multi-beneficial for investors.