Bonus shares are additional shares issued by a company to its current owners at no cost. These shares are used to distribute the company’s grown profits or reserves in the form of stock rather than cash dividends. The number of bonus shares awarded is proportional to the number of shares each shareholder currently owns.
Key Points About Bonus Shares
- Purpose:
Companies offer bonus shares to cut the price per share, and hence attract the common investor, or to share value with the holders without had resorting to cash.
- Effect on Share Capital:
Bonus shares improve the total share capital of the company but have no impact on the market capitalization because the price of the stocks is readjusted for the issue of the new shares.
- Eligibility:
Bonus shares are issued to shareholders who have bought the shares prior to the record date.
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Why Do Companies Issue Bonus Shares?
Encouraging Retail Participation:
When a company’s share price is high, it can be intimidating or unaffordable for small investors. Issuing bonus shares lowers the stock price, making shares more affordable for retail investors, which can improve liquidity (the ease of buying and selling shares).
Alternative to Dividends:
Among strong earnings and strained profits, bonus shares are a great way to enrich the shareholders without providing actual cash dividends. This can also help as confidence to shareholders, particularly the small businesses that intend to attract more investors.
Signalling Financial Health:
Companies issue bonus shares to show that they are in good financial shape. By distributing additional shares from their reserves, they demonstrate stability and growth potential, which can build investor trust.
Types of Bonus Shares
There are two primary types of bonus shares:
Fully Paid Bonus Shares:
These are fully paid shares issued by the company from its reserve or retained earnings account. It does not demand any extra amount from shareholders, unlike some other forms of business entities.
Partially Paid Bonus Shares:
These are shares that were issued to shareholders with subscriptions partially paid while the remaining sum is due on call by the company. There can sometimes be an element of fully paid for on these shares as a result of a bonus issue.
Advantages
For the Company:
- Reduces cash outflow through the issuance of shares rather than issuing of dividends.
- Affordability shows a good financial health that is beneficial to investors if the idea convinces them.
- Increases liquidity as price of the stock comes down.
For Investors:
- Add to their holdings without having to pay for it.
- Lucky for companies, bonus shares are not subject to tax at point of issue and only capital gains tax may be required in the event of sale at a profit.
- It is good for those who are long term investors who want to build up their stocks.
Disadvantages
For the Company:
- Less amount of cash inflow from bonus shares since it will reduce cash availabilities for other sound opportunities.
- Restricts future possible dividend distributions when it goes for bonus shares instead of giving dividends.
For Investors:
- Besides, bonus shares do not offer a direct increase in value as the price of the shares also comes down.
- Shareholders who in particular; prefer regular dividend income may be dissatisfied with a company’s decision to continuously declare bonus shares.
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Conclusion
Bonus shares are an exciting way for companies to reward their loyal shareholders and to attract new investors by making shares more affordable. For investors, they offer a tax-efficient way to increase holdings and can be especially appealing for those in it for the long haul.
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