Bonus Issue

A bonus issue, also known as a scrip issue or capitalization issue, refers to the process by which a company provides additional shares to its existing shareholders without any extra cost, based on the number of shares that a shareholder already owns. This corporate action is an alternative to paying dividends in cash and is often perceived as a way for companies to reward shareholders. However, from a financial perspective, a bonus issue does not change the overall value of the company; rather, it simply increases the number of shares outstanding.

Mechanism of Bonus Issue

When a company decides to issue bonus shares, it converts part of its reserves, retained earnings, or share premium account into equity capital. This conversion does not bring any additional cash into the company but reallocates the portion of reserves into share capital. The process can be broken down into the following steps:

  1. Announcement: The company’s board of directors announces the decision to issue bonus shares with details such as the ratio of bonus shares to existing shares (e.g., 1:2 bonus issue means one bonus share for every two existing shares).

  2. Approval: The bonus issue decision needs to be approved by the shareholders in the company’s general meeting.

  3. Record Date: The company sets a record date to determine which shareholders are eligible to receive the bonus shares. Only those who are shareholders as of that date will receive the stock.

  4. Issuance: After approval and on the record date, the company issues the bonus shares and credits them to the shareholders’ accounts.

Impact on Shareholders and Stock Price

Shareholding Pattern

Stock Price Adjustment

Post-bonus issue, the share price typically adjusts downward. For example, if a shareholder owns 100 shares at $10 each and receives a 1:1 bonus issue (100 additional shares), the total shares become 200. The stock price would likely adjust to $5 per share, keeping the total value unchanged ($1000). This price adjustment is automatic and factored into trading on the ex-bonus date (the date when the stock starts trading without the value of the bonus shares).

Market Perception

Strategic Reasons for Bonus Issues

  1. Attractiveness to Investors: By issuing bonus shares, companies make their stock more affordable. A lower share price can attract small and retail investors, thus increasing the stock’s liquidity.

  2. Utilization of Reserves: Bonus issues allow companies to capitalize their reserves efficiently, showcasing the financial stability of the company.

  3. Signaling Effect: Bonus shares can signal to the market that the company has strong future earnings prospects.

  4. Dividend Policy: For companies that cannot or prefer not to pay large cash dividends, issuing bonus shares serves as an alternative to reward shareholders.

Examples of Bonus Issues

Many well-known companies regularly undertake bonus issues. For instance:

Advantages and Disadvantages of Bonus Issues

Advantages

  1. Shareholder Reward: Bonus shares reward loyal shareholders without the need for the company to disburse cash.
  2. Increased Liquidity: More shares in the market enhance trading and liquidity.
  3. Positive Market Sentiment: Bonus issues can enhance the company’s market image and investor confidence.
  4. Capital Structure Optimization: Utilizing reserves for issuing shares balances the company’s equity structure.

Disadvantages

  1. No Change in Fundamental Value: Although additional shares are issued, the fundamental value and per-share earnings of the company remain unchanged.
  2. Potential Overvaluation: Positive market sentiment can lead to short-term overvaluation.
  3. Administrative Costs: The process involves administrative and regulatory compliance costs.

Accounting for Bonus Issues

From an accounting perspective, a bonus issue involves the transfer of an amount from reserves or retained earnings to share capital. Here are key steps:

  1. Debiting Reserves: The accounting entry involves debiting the appropriate reserve accounts (e.g., retained earnings) to the extent of the bonus issue.

  2. Crediting Share Capital: Simultaneously, the share capital account is credited with the total nominal value of the newly issued shares.

Example Journal Entry:

   Dr. [Retained Earnings](../r/retained_earnings.html)                  $1,000,000
   Cr. Share [Capital](../c/capital.html)                     $1,000,000

Regulatory Framework and Compliance

The regulatory requirements for bonus issues vary by country but generally include:

  1. Board Approval: Initial approval by the company’s board of directors.

  2. Shareholder Approval: Approval by shareholders in the annual general meeting or an extraordinary general meeting.

  3. Stock Exchange Regulations: Compliance with stock exchange listing regulations, such as prior intimation, disclosure, and adjusting indices to reflect the bonus issue.

  4. Disclosure Requirements: Timely and transparent disclosure to prevent any misinformation and enable informed investor decisions.

Conclusion

Bonus issues are a strategic tool used by companies to reward shareholders, alter their capital structure, and sometimes enhance market value. While they do not immediately improve the intrinsic value of a company, they can signify financial health and future growth potential. Investors should understand the implications of bonus issues on their portfolio to make well-informed decisions. For companies, it is a balancing act between maintaining reserves and optimizing their equity base for long-term growth.