Bonus Issue

Published Apr 6, 2024

Definition of Bonus Issue

A bonus issue, also known as a scrip issue or a capitalization issue, refers to the process by which a company distributes additional shares to its shareholders without any extra cost based on the number of shares that they already hold. This is typically executed by converting the company’s retained earnings or other reserve accounts into share capital. It does not involve the inflow of new funds but redistributes the company’s reserves to its share capital account. As a result, while the total number of shares increases, the individual value of each share decreases, but the overall market capitalization of the company (initially) remains unchanged.

Example

Consider a company, XYZ Corp, that decides to issue a 1:4 bonus issue. This means for every four shares an investor holds, they receive one additional share free of charge. If an investor owns 400 shares of XYZ Corp, they would receive 100 additional shares, making their total holdings 500 shares after the bonus issue. The effect of the bonus issue would be a reduction in the share price to adjust for the increased number of shares but the total value of the shareholder’s holdings remains the same immediately after the bonus issue.

Why Bonus Issue Matters

A bonus issue is often interpreted positively by the market as it signals that a company is confident enough in its future prospects to redistribute its profits to shareholders rather than retaining them for internal use or future projects. It can also make shares more accessible to small investors due to the reduced share price post-issue, potentially increasing liquidity. Furthermore, for existing shareholders, it provides additional shares which could lead to greater dividends in absolute terms in the future, assuming the company continues to perform well.

Frequently Asked Questions (FAQ)

How is a bonus issue different from a stock split?

While the mechanical outcomes of a bonus issue and a stock split may appear similar—both lead to an increase in the number of shares and a decrease in the share price—the accounting treatments differ. A stock split simply divides the existing shares into more shares, changing the face value of the shares but not affecting the company’s reserves or capital. On the other hand, a bonus issue converts retained earnings into share capital, affecting the company’s financial structure.

Does a bonus issue affect the share price?

Yes, a bonus issue typically results in a reduction of the share price on an ex-bonus basis, which adjusts to reflect the increase in the number of shares issued. However, the total market value of all shares held by investors remains the same immediately after the bonus issue, as the drop in share price is proportionate to the increase in the number of shares.

What are the advantages of a bonus issue for investors?

For investors, a bonus issue can have several advantages. Firstly, it increases the number of shares held, potentially leading to higher dividend payments if the company continues to perform well. Secondly, the lower share price post-issue may attract more investors, potentially increasing the share’s liquidity and value over time. Finally, it signals company confidence in its future prospects, which can be seen as a positive indicator by the market.

Can a bonus issue lead to tax advantages?

Yes, unlike cash dividends, bonus issues are not taxed at the time of distribution as they are considered a reapplication of a company’s earnings rather than a distribution of profit. This can provide a tax advantage to shareholders in certain jurisdictions where dividends are taxable income. However, tax laws vary by country, and shareholders should consult local tax regulations to understand the implications fully.

What impact does a bonus issue have on a company?

For the company, a bonus issue helps to conserve cash while still rewarding shareholders. It can also improve the liquidity of shares by making them more affordable to small investors, potentially broadening the investor base. Moreover, it can serve as a tool for signaling the company’s growth prospects and financial health to the market. However, it also dilutes the share value, which might have varying effects on shareholder perception and market value in the short term.
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