Bonus shares are additional shares given to existing shareholders without any extra cost, based on the number of shares that a shareholder already owns. This guide will explain what bonus shares are, why companies issue them, their benefits, and provide an example for better understanding.
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What are Bonus Shares?
Bonus shares are free shares that a company gives to its existing shareholders. These shares are distributed from the company’s reserves or profits and do not require shareholders to invest additional money. When a company issues bonus shares, the total number of shares increases, but the overall value of the shares remains the same.
Key Features of Bonus Shares
- No Additional Cost: Shareholders do not pay any money to receive bonus shares.
- Proportionate Distribution: Bonus shares are distributed in proportion to the number of shares already held by shareholders.
- Increases Share Capital: The issuance of bonus shares increases the company’s total share capital.
Why Do Companies Issue Bonus Shares?
1. To Reward Shareholders
Issuing bonus shares is a way to reward shareholders for their loyalty and investment in the company. It shows the company’s confidence in its future profitability.
2. To Capitalize Reserves
When a company has large reserves or retained earnings, it can capitalize these reserves by issuing bonus shares instead of paying dividends.
3. To Improve Liquidity
By increasing the number of shares, bonus shares can improve the liquidity of the stock, making it easier to trade in the market.
4. To Adjust Share Price
Bonus shares can help in reducing the share price to a more attractive level, making the stock more affordable for small investors.
Benefits of Bonus Shares
1. For Shareholders
- Increased Holdings: Shareholders receive additional shares without any extra cost.
- Tax Benefits: In some jurisdictions, bonus shares are not immediately taxable, providing a tax benefit to shareholders.
- Enhanced Value: While the total value remains the same, shareholders have more shares, potentially increasing their investment value over time.
2. For Companies
- Retained Earnings Utilization: Companies can effectively use their retained earnings without paying out cash.
- Market Perception: Issuing bonus shares can positively affect the market perception, indicating the company’s strong financial health.
- Share Price Adjustment: It helps in adjusting the share price to make it more attractive and affordable for investors.
How Bonus Shares are Issued
Step-by-Step Process
- Board Approval: The company’s board of directors approves the proposal to issue bonus shares.
- Shareholder Approval: The proposal is presented to shareholders for approval in a general meeting.
- Record Date: A record date is set to determine which shareholders are eligible to receive the bonus shares.
- Distribution: Bonus shares are distributed to eligible shareholders based on the approved ratio.
Example of Bonus Shares Issuance
Let’s consider a fictional company, “Tech Innovators Inc.,” to understand how bonus shares are issued.
Step-by-Step Example
- Board Approval: The board of directors of Tech Innovators Inc. decides to issue bonus shares in the ratio of 1:2 (one bonus share for every two shares held).
- Shareholder Approval: The proposal is approved by shareholders in the general meeting.
- Record Date: The company sets a record date of August 1, 2024, to determine eligible shareholders.
- Distribution: On August 1, 2024, shareholders who own shares will receive one bonus share for every two shares they hold.
Impact on Shareholders
If a shareholder owns 200 shares of Tech Innovators Inc. before the bonus issue, they will receive 100 additional shares (1 bonus share for every 2 shares). After the bonus issue, the shareholder will have a total of 300 shares.
Impact on Share Price
Assume the market price of Tech Innovators Inc. shares is $30 before the bonus issue. After issuing the bonus shares, the total number of shares increases, and the share price is adjusted. The new share price will be approximately $20 ($30 x 2/3), making the shares more affordable while keeping the overall value of the investment unchanged.
Conclusion
Bonus shares are a beneficial tool for both companies and shareholders. They provide an effective way to reward shareholders, capitalize reserves, and improve the liquidity of the stock. By understanding the concept of bonus shares, shareholders can better appreciate how their investments can grow without any additional cost. Companies can use bonus shares to demonstrate their financial strength and maintain a positive market perception.
References
- Investopedia. (n.d.). Bonus Share.
- AccountingCoach. (n.d.). Bonus Shares.