Bonus shares are additional shares that are issued to existing shareholders of a company at no additional cost. The existing shareholders are simply allocated additional shares in proportion to the number of shares currently held by them.
The common trend is to indicate bonus shares as a proportion. For example, if a company comes out with a 1:1 bonus announcement, it indicates that it will allocate investors one bonus share for every share held in the company.
Bonus issue has no impact on shareholder’s wealth
A bonus issue is generally effected through a capitalisation of the free reserves of the company. It increases the equity base of the company, however, does not have any impact on the shareholders wealth. This is captured with the help of the following example:
|Ginger Ltd [1:1 Bonus Issue]|
|Isuued Equity Capital||100000||200000|
|FV Per Share||10||10|
|No Of Shares Outstanding||10000||20000|
|Market Price Per Share||50||25|
Note that the market price of the shares will fall in proportion to the number of Bonus shares issued. In the present case, the bonus being 1:1, the market price of the shares fell by exactly 50% on the ex-date (the market capitalisation remaining the same). This is a bonus issue is simply a rearrangement between the equity capital and the free reserves of a company and does not bring about any value addition.
A bonus issue does not involve any outflow of cash.
Bonus issue encourages retail participation
As a bonus issue leads to a fall in the market price of shares (increase in number of shares outstanding), it makes the shares of company more accessible to retail investors (who generally shy away from high priced shares). A bonus issue thus helps to encourage retail participation and is similar in many aspects to stock-split. However, unlike a stock-split a bonus issue does not lead to a change in the face value of shares.