Bonus shares are additional shares the company gives 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 cannot pay a 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, 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. It 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 ‘capitalization’ of the profits. The company cannot charge the shareholders for the issue of bonus shares. A sum equal to the bonus issue’s value is adjusted against the profits or the reserve and then transferred to the Equity Shares Capital Account.
What is a bonus issue?
The term bonus issue or bonus share issue is used to define an issue of bonus shares. A bonus issue is based on the number of shares held by a shareholder. 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 claims due to a bonus issue. It 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 asset’s value remains unaltered because the shareholder owns a larger number of shares despite a decrease in the income per share. 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 assures the company can service its larger equity. It means that the company would not have issued bonus shares if it could not guarantee increased profits from the shares and distribution of dividends in the future. Therefore, a bonus issue also promotes company goodwill. Companies issue bonus shares following the constant ratio formula that allows each shareholder a fixed number of shares based on the number of outstanding shares.
Advantages and Disadvantages of Issuing Bonus Shares
Companies low on cash may issue bonus shares rather than cash dividends to provide income to shareholders. Because issuing bonus shares increases the company’s issued share capital, the company is perceived as being bigger than it is, making it more attractive to investors. In addition, increasing the number of outstanding shares decreases the stock price, making the stock more affordable for retail investors.
However, issuing bonus shares takes more money from the cash reserve than issuing dividends. Also, because issuing bonus shares does not generate cash for the company, it could result in a decline in the dividends per share in the future, which shareholders may not view favorably. In addition, shareholders selling bonus shares to meet liquidity needs lower shareholders’ percentage stake in the company, giving them less control over how the company is managed.
Who is eligible for bonus shares?
Shareholders who own company shares before the record date and the ex-date set by the company are eligible for bonus shares. India follows the T+2 rolling system to deliver 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 fifteen days.
What is the benefit of issuing bonus shares?
A company facing liquidity issues offers bonus shares to existing shareholders to avoid paying a cash dividend. Companies issue bonus shares to increase the number of equity shares in the market. It makes the company attractive to investors and makes shares affordable by lowering the share price.
How bonus shares will be credited?
The bonus shares will get credited to your DEMAT account. The process usually takes 10-15 days. Bonus shares are additional shares allotted free of cost to shareholders. Companies reserve a portion of their profit, a part not paid as a 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?
The issue of bonus shares impacts the company’s share price, falling in the same proportion as the shares are issued. For example, if bonus shares are issued in a 1:1 ratio, the share price will fall 50 percent. However, this impact is temporary. Long-term investors tend to gain when share prices rise again in the long run.
Is dividend paid on bonus shares? Is bonus share good for investors?
The dividend calculation depends on your DEMAT account’s total number of shares. When the company announces a dividend, it doesn’t segregate whether the shares in your account are rights issues or bonus shares. Bonus shares are multi-beneficial for investors.
- You are not required to pay any tax on the bonus shares
- You gain in the long run as share prices go up by liquidating additional shares you received as a bonus
- When the company declares a dividend, you receive a higher dividend for the number of shares
- Bonus shares signify the company is committed to long-term success, gives a positive sign to the market
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