A bonus issue, also known as a scrip issue or capitalization issue, is an offer of free additional shares by a company to its existing shareholders. These are distributed in proportion to the number of shares already held. A bonus issue is essentially a method for a company to distribute its accumulated profits to shareholders without paying out any cash.
How Does a Bonus Issue Work?
Mechanism and Calculation
In a bonus issue, a company converts its reserves (such as retained earnings) into share capital. For instance, if a company announces a 1:5 bonus issue, it means that shareholders will receive one additional share for every five shares they currently hold. The process involves:
- Announcement: The company announces the bonus ratio and record date.
- Record Date: Shareholders on record as of this date are eligible to receive the bonus shares.
- Allocation: New shares are issued and allocated to eligible shareholders, increasing the total number of shares outstanding.
Example
Consider a shareholder who owns 100 shares of Company ABC, which announces a 1:5 bonus issue. Upon issuance, the shareholder will receive 20 additional shares, bringing their total holding to 120 shares.
Implications of a Bonus Issue
Impact on Share Price
Post bonus issue, the price of the shares is expected to adjust downward due to the increased number of shares in circulation. However, the market capitalization and the shareholder’s proportional ownership remain unchanged.
Stock Market Perception
Often, a bonus issue is perceived positively by the market as it indicates strong accumulated reserves and confidence in future profitability. It can also increase liquidity by making shares more affordable to a broader range of investors.
Comparison with Stock Splits
A stock split involves dividing the existing shares into multiple shares, while the company’s market capitalization remains the same. Unlike bonus issues, stock splits do not convert reserves into share capital. Both methods aim to increase liquidity and make shares more affordable, but differ fundamentally in execution and financial implication.
FAQs
Why Do Companies Issue Bonus Shares?
How Does a Bonus Issue Impact Earnings Per Share (EPS)?
Are Bonus Shares Taxable?
Historical Context
The practice of issuing bonus shares dates back to the early 20th century, primarily in the United States and the United Kingdom. It was a popular method during periods of economic growth to reward shareholders and maintain investor confidence.
Related Terms
- Dividend: A payment made by a corporation to its shareholders, usually in the form of cash or additional stock.
- Authorized Shares: The maximum number of shares that a company is legally authorized to issue.
- Market Capitalization: The total market value of a company’s outstanding shares.
Summary
A bonus issue is a cost-effective way for companies to distribute profits without reducing cash reserves, resulting in increased share issuance and liquidity. While the share price and EPS adjust accordingly, the overall value for shareholders remains the same, making it an attractive tool for companies to bolster market perception and shareholder satisfaction.
References
- InvestorGuide. (2020). “Understanding Bonus Shares and Their Impact.”
- Financial Times Lexicon. (2021). “Bonus Issue.”
- Investopedia. (2022). “Bonus Issue Definition.”
This entry provides a complete understanding of bonus issues, encapsulating their mechanism, impact, historical context, and comparison with other financial concepts. Through detailed exploration and clear examples, it ensures that readers gain a well-rounded perspective on the subject.
