Bonus Issue: Definition and Importance

An issue of additional shares in a company to existing shareholders, in proportion to their holdings.

Overview

A Bonus Issue, also known as a scrip issue or capitalization issue, refers to the distribution of additional shares to existing shareholders of a company without any cost. It is done in proportion to the shareholders’ current holdings and is an indication of the company’s good financial health.

Historical Context

The concept of bonus issues has been utilized by companies since the early 20th century. It gained popularity as an efficient means to reward shareholders without depleting the company’s cash reserves. Historically, bonus issues have been used to signify confidence in a company’s future prospects.

Types/Categories

1. Proportion-Based Bonus Issue

• 1:1 Bonus Issue: For every share held, an additional share is issued.
• 2:1 Bonus Issue: For every two shares held, an additional share is issued.

2. Retention of Earnings

• Companies retain earnings to reinvest in the business.
• Part of retained earnings can be capitalized to issue bonus shares.

Key Events

1. Approval by the Board of Directors: The company’s board decides on the ratio and necessity of a bonus issue.
2. Shareholder Approval: General meetings are held to get shareholder approval for the bonus issue.
3. Record Date Announcement: A specific date is set to determine eligibility for the bonus shares.
4. Bonus Shares Distribution: Bonus shares are credited to shareholders’ accounts.

Detailed Explanation

A bonus issue essentially capitalizes a part of the company’s reserves or surplus. It adjusts the company’s balance sheet but does not change the net worth. Here’s how it works:

Step-by-Step Process

1. Decision: The board proposes a bonus issue based on financial performance.
2. Approval: The shareholders approve this proposal in a meeting.
3. Implementation: On the record date, shareholders receive additional shares as per the declared ratio.
4. Post-Issue: Share price adjusts due to the increased number of shares.

Mathematical Model

To calculate the effect of a bonus issue on the share price:

$$ \text{New Share Price} = \frac{\text{Old Share Price}}{1 + \text{Bonus Ratio}} $$

Example:
If the old share price is $100 and the company announces a 1:1 bonus issue:

$$ \text{New Share Price} = \frac{100}{1+1} = \frac{100}{2} = $50 $$

Chart and Diagram (Mermaid Format)

    graph TD
	A[Company Reserves] -->|Capitalization| B{Bonus Issue Decision}
	B -->|Approval| C[General Meeting]
	C -->|Announcement| D[Record Date]
	D -->|Issuance| E[Shareholders Receive Bonus Shares]

Importance and Applicability

1. Shareholder Reward: Encourages long-term investment by rewarding shareholders without paying cash.
2. Market Signal: Demonstrates company confidence, potentially increasing the stock’s market value.
3. Liquidity Increase: Increases the number of shares available, improving market liquidity.

Examples

• Example 1: Infosys, in 2018, issued a 1:1 bonus issue.
• Example 2: Tata Motors, in 2015, declared a 6:1 bonus issue.

Considerations

• Market Perception: Overuse of bonus issues can dilute stock value.
• Administrative Costs: Managing bonus issues entails operational costs.
• No Cash Inflow: Unlike rights issues, bonus issues do not bring additional funds.

Related Terms

1. Rights Issue: Shareholders are given the option to purchase new shares at a discount.
2. Stock Split: Dividing existing shares into multiple ones to boost liquidity.

Comparisons

• Bonus Issue vs. Rights Issue: Rights issues require shareholders to pay for new shares; bonus issues are free.
• Bonus Issue vs. Stock Split: Stock splits change the face value of shares; bonus issues capitalize reserves.

Interesting Facts

• Dividend Proportion: Bonus issues often follow a profitable period with healthy dividends.
• Global Practices: Different regulations exist globally concerning bonus issues.

Inspirational Stories

Warren Buffett has consistently praised companies that issue bonus shares as a mark of their confidence and strong performance, encouraging shareholders to hold for the long term.

Famous Quotes

“Investment in bonus shares is not just rewarding for shareholders but is a mark of trust and success.” - Ratan Tata

Proverbs and Clichés

• “The more, the merrier” can reflect how investors feel about receiving additional shares.

Expressions, Jargon, and Slang

• Blue-Chip Companies: Often associated with companies that issue bonus shares.
• Capitalize Reserves: Utilizing retained earnings for issuing bonus shares.

FAQs

Q1. Why do companies issue bonus shares?

A. To reward shareholders and indicate financial strength without using cash reserves.

Q2. Does a bonus issue affect share price?

A. Yes, the share price typically adjusts downward proportionally to the bonus ratio.

References

1. Investopedia on Bonus Issues: Link
2. Financial Times Lexicon: Link

Summary

Bonus issues are a strategic tool used by companies to reward shareholders, signify confidence in future prospects, and increase share liquidity without impacting cash reserves. Understanding the implications and processes involved in bonus issues is crucial for investors and companies alike.

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