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Bonus Shares: Meaning, Examples, Advantages, Disadvantages, & More!
Bonus shares are a common corporate action where companies reward their shareholders by issuing additional shares at no extra cost. This is done to capitalize on the company’s reserves, enhance liquidity, and make stock ownership more attractive to investors. The issuance of bonus shares does not dilute shareholders' value but increases the number of outstanding shares proportionately.
This article covers bonus shares meaning, the process of issuing them, advantages and disadvantages, tax implications, and a comparison with stock splits.
What is a Bonus Share?
Bonus shares, also known as scrip dividends, are issued when a company has substantial retained earnings but prefers to reinvest its profits rather than distribute them as cash dividends. These shares increase shareholder confidence and improve liquidity in the stock market, making the stock more affordable for retail investors.
In other words, a bonus share is a free share of stock given to existing shareholders based on the number of shares they already hold. Companies issue bonus shares from their accumulated profits or reserves instead of distributing cash dividends. These shares serve as a means to reward shareholders without impacting the company’s cash flow.
Key Features of Bonus Shares
Bonus shares are additional shares issued by a company to its existing shareholders without any extra cost, typically in proportion to their current holdings.
Below is a detailed explanation of their key features along with examples:
1. Issued Free of Cost
Shareholders receive bonus shares without making any payment. These shares are issued as a reward for their investment and loyalty to the company.
Example: Suppose you own 100 shares of a company, and it announces a 1:1 bonus issue. You will receive 100 additional shares for free, doubling your total holding to 200 shares without any cost to you.
2. Allocated in a Ratio
Bonus shares are distributed in a fixed proportion based on the number of shares already owned by shareholders. Common ratios include 1:1, 2:1, or 3:2.
Example:
- 1:1 Ratio → If you own 50 shares, you receive 50 extra shares (total: 100).
- 2:1 Ratio → If you own 50 shares, you receive 100 extra shares (total: 150).
- 3:2 Ratio → If you own 50 shares, you receive 75 extra shares (total: 125).
3. No Cash Outflow for the Company
Unlike dividend payouts, which require cash payments, bonus shares are issued from the company's reserves (retained earnings or share premium), meaning the company does not spend cash.
Example: A company with strong financial reserves but wanting to retain liquidity for expansion may issue bonus shares instead of paying dividends. For instance, if a company has ₹100 crore in retained earnings, it may allocate a portion of these reserves to issue bonus shares instead of paying cash dividends.
4. Increases Outstanding Shares
The number of shares in circulation rises, but the company’s overall valuation (market capitalization) remains unchanged. The stock price usually adjusts accordingly.
Example:
- Before Bonus Issue: A company has 10 lakh shares priced at ₹100 each (Market Cap = ₹10 crore).
- After a 1:1 Bonus Issue: The total shares double to 20 lakh, but the stock price adjusts to ₹50 per share (Market Cap still ₹10 crore).
Reasons for Issuing Bonus Shares
Companies issue bonus shares for several strategic reasons, benefiting both the organization and its shareholders. These reasons include increasing market liquidity, rewarding investors, signaling financial strength, and making shares more affordable.
Enhancing Market Liquidity
One of the primary reasons for issuing bonus shares is to increase market liquidity. When a company issues additional shares, the total number of shares available for trading rises.
This often leads to higher trading volumes, making it easier for investors to buy and sell shares. Improved liquidity can also reduce price volatility, making the stock more stable and attractive to investors.
Rewarding Shareholders
Bonus shares serve as a way for companies to reward their existing shareholders without distributing cash dividends. Instead of paying out profits in cash, companies issue additional shares, giving investors a greater stake in the company at no extra cost.
This is especially useful for companies that want to retain cash for expansion or operational needs while still acknowledging shareholder contributions.
Signaling Financial Strength
Issuing bonus shares is often seen as a signal of strong financial health. It indicates that a company has healthy retained earnings and confidence in its future growth.
Investors generally perceive this as a positive sign, reinforcing trust in the company’s stability and long-term profitability. A well-timed bonus issue can boost investor confidence and attract more interest in the stock.
Making Shares More Affordable
Bonus issues help in reducing the share price while maintaining the company's overall market capitalization. When more shares are issued, the price per share adjusts downward, making it more affordable for retail investors.
A lower share price can lead to increased demand and broader investor participation, ensuring better accessibility and wider ownership.
Bonus Issue of Shares
A bonus issue of shares is the process by which a company distributes additional shares to its shareholders in proportion to their existing holdings.
Steps in a Bonus Issue
Step 1: Board Approval
The Board of Directors passes a resolution proposing the bonus issue.
The decision is based on the company’s financial health and availability of reserves.
Step 2: Shareholder Approval
The proposal is presented to shareholders at the Annual General Meeting (AGM) or an Extraordinary General Meeting (EGM).
Shareholders must approve the issuance as per the provisions of the Companies Act and the company’s Articles of Association.
Step 3: Regulatory Compliance
The company must comply with stock exchange and regulatory guidelines (e.g., SEBI regulations in India).
Necessary filings are made with the stock exchanges and the securities regulator.
Step 4: Record Date Announcement
The company announces a record date, which is the cut-off date to determine eligible shareholders.
Shareholders who hold shares on this date will receive bonus shares.
Step 5: Bonus Share Allotment
The bonus shares are credited to eligible shareholders' demat accounts in the specified ratio (e.g., 1:1 bonus means one additional share for every existing share).
No payment is required from shareholders, as these shares are issued from the company’s reserves.
Effects of a Bonus Issue
- No Change in Market Capitalization: The total value of the company remains unchanged, as reserves are converted into share capital.
- Lower Share Price: Since more shares are in circulation, the stock price usually adjusts downward.
- Dilution of Earnings Per Share (EPS): As the number of shares increases, EPS may decrease, but the company’s intrinsic value remains the same.
- No Impact on Shareholding Percentage: Shareholders maintain the same proportionate ownership in the company.
Example of Bonus Share Issue
A company announces a 1:2 bonus issue, meaning shareholders receive one additional share for every two shares held.
| Shareholder | Existing Shares | Bonus Shares (1:2) | Total Shares After Bonus |
| Investor A | 100 | 50 | 150 |
| Investor B | 200 | 100 | 300 |
Advantages & Disadvantages of Bonus Shares
The pros and cons of bonus shares are as follows:
Advantages of Bonus Shares
| Increases Shareholder Wealth | Investors receive additional shares at no cost. |
| Enhances Liquidity | More shares in circulation lead to higher trading activity. |
| Boosts Investor Confidence | Signals strong financial health of the company. |
| Adjusts Share Price | A lower per-share price makes the stock more affordable. |
| Tax Benefits | Unlike dividends, bonus shares do not result in immediate tax liabilities. |
Disadvantages of Bonus Shares
| No Immediate Financial Gain | Unlike cash dividends, bonus shares do not provide an immediate monetary benefit. |
| Possible Dividend Reduction | Since earnings per share (EPS) decrease, future cash dividends per share may also decrease. |
| Reserves Depletion | Issuing bonus shares reduces the company’s reserves, which could be used for expansion or other investments. |
Bonus Share versus Stock Splits: Comparison
Bonus shares and stock splits are two corporate actions that increase the number of shares available in the market, but they differ in purpose, execution, and financial impact.
| Bonus Shares | Stock Split | |
|---|---|---|
| Definition | Additional shares issued to existing shareholders for free by capitalizing reserves. | Division of existing shares into smaller units, reducing the nominal value per share. |
| Purpose | To reward shareholders and capitalize retained earnings or reserves. | To make shares more affordable and improve liquidity. |
| Impact on Share Capital | Increases as reserves are converted into equity. | No change in total share capital. |
| Impact on Face Value | No change; the face value remains the same. | Reduced in proportion to the split ratio (e.g., 10 → 5). |
| Example | 1:1 bonus issue → A shareholder with 100 shares gets 100 additional shares. | 2-for-1 split → A shareholder with 100 shares now has 200 shares, but each is worth half as much. |
| Earnings Per Share (EPS) | Decreases as total outstanding shares increase. | Decreases as shares increase, but no change in company’s financials. |
| Market Price Impact | Share price decreases in proportion to the bonus ratio. | Share price falls in proportion to the split ratio. |
| Effect on Shareholder Value | No direct impact on value; total ownership remains the same. | No direct impact; only increases liquidity. |
| Accounting Treatment | Reserves are reduced, and share capital is increased. | No change in reserves or share capital. |
Tax Implications of Bonus Shares
When a company issues bonus shares, shareholders do not incur any tax liability at the time of receipt since these shares are given for free. However, taxation applies when the shareholder sells them. Capital gains tax is levied based on the selling price, and the acquisition cost of bonus shares is considered zero or as per tax regulations.
The holding period for determining short-term or long-term capital gains tax is calculated from the date of allotment of the bonus shares.
Conclusion
To sum up, a bonus issue of shares is a strategic corporate action that rewards existing shareholders by increasing their shareholding without any additional investment. While it enhances market liquidity and investor confidence, it does not alter the company’s overall valuation.
Compared to a stock split, which only reduces the nominal value of shares, a bonus issue capitalizes on the company’s reserves to expand its equity base. Shareholders should also consider the tax implications, as capital gains tax applies when selling bonus shares. Understanding these aspects helps investors make informed decisions about their holdings.
Frequently Asked Questions (FAQs)
1. How are bonus shares different from stock splits?
Bonus shares are new shares issued free of cost, while a stock split divides existing shares into multiple smaller shares, reducing the price per share but keeping the total value unchanged.
2. Do bonus shares impact a company’s profits?
No, issuing bonus shares does not affect a company’s profits since they are issued from retained earnings and reserves.
3. Are bonus shares taxable?
Bonus shares are not taxed at issuance, but capital gains tax applies when they are sold.
4. Can all companies issue bonus shares?
No, only companies with sufficient reserves and strong financial health can issue bonus shares.
5. What happens to the share price after a bonus issue?
The share price typically decreases in proportion to the bonus issue ratio, maintaining the overall value of an investor’s holdings.
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