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Arranging the necessary capital to run the business is hectic but it is the most basic requirement for every company. While smaller companies rely on self-investments and loans, large public companies resort to public funds.
So, how do public limited companies reward their shareholders for investing money in them? Yes, dividends are one of the ways. But, rewards over and above the expected income are always attractive. Aren’t they?
Issuing bonus shares is an effort in that direction. Let us explore bonus shares, their benefits and why companies issue them.
What is a bonus share?
Bonus share, as the name suggests, is a bonus issue of shares to investors. It is a corporate action where companies issue additional shares to existing shareholders free of cost.
- What is a bonus share ratio?
Bonus share ratio refers to the ratio at which a company issues additional shares to an investor. It determines the number of extra shares an investor gets for each share held.
- What is the record date for bonus shares?
The record date is a significant component of corporate actions. The record date is the date when companies check the list of existing shareholders to determine the eligible shareholders who will participate in the corporate action.
Ex-date is another significant date for corporate actions. Regarding bonus shares, ex-date is the deadline date for investors to invest in the company to get the benefits of the bonus issue.
So, investors are eligible for bonus shares if they invest before the ex-date and continue to hold shares on the record date.
Why are bonus shares issued?
There are various reasons for companies to issue bonus shares. Issuing bonus shares acts like an advertisement to attract more investors to a company’s stock.
When bonus shares are issued, a company’s shares increase, making the stock more liquid. Also, the price per share comes down. Share prices come down in the same ratio of issuing bonus shares, making them more accessible to investors.
Companies also do this to reward their existing shareholders for their contribution towards the business. By doing so, the company increases its image and goodwill.
Despite the benefits, one limitation of issuing bonus shares is the opportunity cost. Companies choose to issue bonus shares and forego the option to invest the cash in reserves into more productive sources and earn more income.
- How to calculate bonus shares?
The company’s management decides the bonus ratio and impacts two aspects – the number of shares available and the price per share.
Here is an example to understand better:
- Company ABC has a market capitalisation of ₹10 lakhs, 10,000 shares, and a share price of ₹100.
- It issues a 4:1 bonus, giving four extra shares for each share held.
- After the bonus (10,000*4 = 40,000), it has 50,000 shares, a share price of ₹20, and the same market capitalisation.
So, the market capitalisation does not change after a bonus issue because the number of shares increases and the prices decrease to adjust themselves in the ratio of bonus issue.
Impact of bonus shares on investors
The primary benefit for shareholders is to receive shares free of cost. Receiving bonus shares is tax-free. However, tax on capital gains is applicable if investors sell their bonus shares in the secondary market.
However, one of the disadvantages is not receiving cash dividends. Companies choose to issue dividends in the form of bonus shares instead of cash.
Example of bonus issue
Berger Paints, a well-known Indian multinational paint company, announced the issuance of bonus shares in September 2023.
The details were as follows:
- Bonus ratio – 1:5 (5 extra shares for every share)
- Record date – 23 September 2023
Bonus share Vs. stock split
The objective of both these corporate actions is to reward existing shareholders and attract new ones by increasing liquidity and decreasing the price. But bonus shares refer to issuing new, additional shares, whereas stock splits involve splitting the existing shares.
Also, issuing bonus shares does not impact the face value of stocks, but stock splits affect the face value.
Since bonus shares are issued from the company’s reserves, it talks about the company’s efficiency and stable performance. It is also beneficial for investors since it increases the value of their investments in the long run.
In the case of bonus shares, let’s say a shareholder has 100 shares of company X. If the corporation decides to distribute bonus shares in a ratio of 2:1, this indicates that each shareholder will get two bonus shares for every share that they already own.
Since bonus issues are distributed to current shareholders in a consistent ratio that maintains each shareholder’s total value equal to what was before the issue, they do not reduce the shareholders’ value. It is beneficial to the company’s long-term investors who want to grow their business.
By selling the bonus shares on the open market, the investor may certainly satisfy these liquidity goals, but doing so would similarly lower their stake in the business. When selling bonus shares, investors need to consider the impact on taxes carefully.
When there is a bonus issue, the stock price goes down by the amount of the bonus ratio. However, this drop shouldn’t be mistaken for a fix or a fall in the stock price. At a 2:1 ratio, owners get two free shares for every share they own.