Why Do A Company Issue Bonus Shares?

Hi friends,

Many times we hear the word "Bonus Issue" in the stock market. People get very happy as it is the feeling of getting something "Free" or rewarded. Is it really "Free"? Do we earn profit by selling bonus shares immediately? 

In this blog, we will see everything about bonus shares and their impact on shareholders.

Shareholders when a company declares a bonus issue - "Paisa Hi Paisa Hoga"
Shareholders when a company declares a bonus issue - "Paisa Hi Paisa Hoga"
                              
What is the Bonus issue?
Bonus shares are the extra shares issued by the company to its shareholders. Bonus shares are issued to shareholders by a company instead of cash dividends. A bonus issue is a just corporate action to reduce the price per share. 

Why company will issue bonus shares?
  1. In most cases, the company issue bonus shares when there is a shortage of cash to pay dividends while shareholders are expecting regular income from the company.
  2. To restructure the reserves
  3. In some cases, if a company wants to utilize cash for some other developments and doesn't want to give dividends to shareholders, it issues bonus shares. It also helps a company to gain the trust of shareholders in the company's decision to use cash. 
  4. It helps to take tax benefits and also helps to dilute market value per share.
  5. To encourage retail participation and increase their retail base. In this way, shareholders will remain with the company for a longer period. 
Example of bonus issue: 1:1, 2:1,5:1, 1:5, 1:2

1:1 bonus issue:
It means shareholders will get 1 bonus share for every one share held. 
If you have 100 shares of a company at a share price of 1500 Rs. In that case, you will get additional 100 shares as a bonus.

Total investment before bonus issue = 100 * 1500 = 150000/-
Total number of shares after bonus issue = 100 + 100 = 200
Share price after bonus = 1500/2= 750/-
Total investment after bonus issue = 200 * 750 = 150000/-

2:1 bonus issue:
It means shareholders will get 2 bonus shares for every one share held. 
If you have 100 shares of a company at a share price of 1500 Rs. In that case, you will get additional 200 shares as a bonus.

Total investment before bonus issue = 100 * 1500 = 150000/-
Total number of shares after bonus issue = 100 + 200 = 300
Share price after bonus = 1500/3= 500/-
Total investment after bonus issue = 300 * 500 = 150000/-

1:2 bonus issue:
It means shareholders will get 1 bonus share for every two shares held. 
If you have 100 shares of a company at a share price of 1500 Rs. In that case, you will get additional 50 shares as a bonus.

Total investment before bonus issue = 100 * 1500 = 150000/-
Total number of shares after bonus issue = 100 + 50 = 150
Share price after bonus = 1500*2/3= 1000/-
Total investment after bonus issue = 150 * 1000 = 150000/-

Note: If you see carefully, total investment remains the same before and after the bonus issue. 

Eligibility for bonus shares
You should be a shareholder of the company on the record date. Investors need to buy shares before the ex-date to be eligible for bonus shares. (Read more: What is the Record date & ex-date?) 

Impact of bonus issue on a company:
  1. Share price decreases in the proportion to bonus issues.
  2. The number of outstanding shares increases.
  3. Liquidity increases due to an increase in the share capital of the company.
  4. There are no changes in the company's total net asset value.
  5. The dividend per share decreases as the number of total shares increases.
  6. Earning per share decreased due to an increase in the number of shares but profit remains the same.
  7. Reduces free reserves and the surplus amount and moved to the capital
  8. Reduces book value per share
Impact of bonus issue on shareholders:
  1. The number of shares increases in the proportions of shareholders holding, but total investment remains the same.
  2. There is virtually a drop in profit and loss in holding due to bonus issue adjustments. Once bonus issue shares get credited into account, profit & loss will be adjusted accordingly.
  3. Investments of shareholders remain the same so there is no gain or loss in shareholders' investments.
  4. There will be no tax implication on bonus shares immediately. If shareholders sell the bonus shares with a capital gain, they need to pay tax on the capital gain.
Summary:
  • Bonus shares are the additional shares given to the shareholders by the company without any additional cost. 
  • The bonus issue is just a corporate action. It doesn't have any impact on the market value of the company as well as on shareholders' investments.
  • New shares are issued at the existing face value of shares of the company.
  • The bonus issue will not have any tax implications immediately. When shareholders sell bonus shares with a capital gain, then they need to pay tax.
  • Bonus issue helps to attract more people due to lower ticket size.

Stay Tuned☺
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