Characteristics, History And Consequences Of Bonus Issue

Bonus shares refer to the issue of additional fully paid shares to the existing shareholders of the company without any additional cost to them. This additional issue is done in proportion to the shares already held by the existing shareholders. For example: Suppose initially the total number of outstanding shares of a company is 10,000. If the company issues 1 bonus share for every 2 shares held by the existing shareholders, then the number of outstanding shares will increase to 15000 shares. A shareholder currently holding 500 shares (500/10,000 = 5% of total shares) will receive 250 bonus shares, and his total holding would increase to 750 shares (750/15000 = 5% of total shares) but his proportion of holding in the company (5%) will remain same.

Generally, bonus issue is seen as an enlargement in the holdings of shareholders without dilution in their holding.

Characteristics of bonus shares

• Bonus shares are issued to existing shareholders
• Bonus shares are issued to shareholders free of cost
• Bonus shares are issued to the shareholders in the proportion of shares already owned by them
• Bonus shares are always issued at face value
• Bonus shares cannot be issued at premium
• Bonus shares are usually issued to the equity shareholders
• Bonus shares are issued by the company out of their accumulated profits
• The net worth of the company issuing bonus shares remains the same
• Right to renunciation is not available in case of bonus shares
• No minimum subscription is required for issue of bonus shares
• Shareholders to whom the bonus shares have been issued enjoy voting rights and dividend rights as that of the ordinary shares
• As per The Companies Act 2013, only fully paid bonus shares can be issued.
  Get to Know The Price Estimate For Your Paper

  Topic

  Deadline: 10 days left

  Number of pages

  Email Invalid email

  By clicking “Check Writers’ Offers”, you agree to our terms of service and privacy policy. We’ll occasionally send you promo and account related email

  "You must agree to out terms of services and privacy policy"

  Write my paper

  You won’t be charged yet!

  Get quality help now

  

  Doctor Jennifer

  Verified writer

  Proficient in: Company

  5 (893)

  “ Thank you so much for accepting my assignment the night before it was due. I look forward to working with you moving forward ”

  

  +84 relevant experts are online

  Hire writer

Why do companies issue bonus shares?

A company can choose to issue bonus shares because of various reasons, some of which are-

1. When there are huge unutilized reserves available with the company and they want to capitalize them.
2. When the company has liquid fund crisis in spite of earning good profits, they might declare bonus shares out of reserves instead of paying out dividend.
3. To encourage retail participation and improve liquidity especially if share price of the company is very high.
4. When there is a huge difference between the market value and book value of the shares of the company.
5. To save dividend distribution tax

Historical evolution

East India Company which was formed on December 31, 1600 by the English parliament was the most influential company in global corporate history. During its existence, the company initiated many innovative practices including the practice of issuing bonus shares rather than paying out cash to its shareholders by way of dividend.

In 1682, East India Company issued bonus shares for the very first time as a result of which it doubled its share capital by issuing one bonus share for every share held by its shareholders. By issue of such bonus shares, the company succeeded in converting its partly paid shares of €50 into fully paid shares at free of cost. Issue of bonus shares helped the company in maintaining its liquidity level and lead to an increase in the dividend payments over the next ten years.

The initiative taken by the East India Company lead to the concept of bonus shares being seen as an alternative for rewarding the shareholders in addition to periodic dividend payments. This practice was followed by several other companies. In 1960, Hudson Bay Company issued bonus shares in the ratio of 2:1. Later, the Royal African Company issued bonus in the ratio of 3:1 in the subsequent year. Many such circumstances resulted in establishing the issue of bonus shares as an accepted practice to reward shareholders across the globe.

Stock split vs. Bonus issue

Effectively a stock split could be compared to issue of bonus shares. Stock split refers to the process of a company dividing the existing shares into multiple shares of smaller face value, while the total capital of the company remains the same. For example: a company divides 1,000 shares with face value Rs.10 each, into 2,000 shares with face value of Rs.5 each. The companies generally resort to stock split to convert shares with a high market price more liquid and affordable to retail investors. The market price of such shares adjusts accordingly after the split. When a company declares a bonus issue, the investors acquire bonus shares in proportion to the number of shares they hold free of cost. Both in the case of bonus issue and share split the total number of shares of the company floating in the market increases and the net worth of the company remains the same. Both bonus issue and stock split make the shares increase in number, in the case of stock split the market price fall whereas in case of bonus issue the market price increases. But generally the fall in price of shares in case of stock split is lesser in proportion to the divide in the number of shares, hence in most of the cases the shareholders are still benefiting.

Sources from which bonus shares can be issued

Bonus shares are issued by converting the company’s retained earnings or accumulated reserves into equity share capital.

Fully paid bonus shares can be issued from any of the following sources:

• Securities premium (for listed companies, only if such premium is realized in cash)
• General Reserve
• Capital Redemption Reserve
• Surplus Account/ Profit and Loss Account.

Guidelines governing bonus issue in India

Companies Act, 2013. In India, issue of bonus shares is governed under section 63 of the Companies Act, 2013. The sub-section (1) of the Act lists out various reserves out of which bonus issue shall be made. The sub-section (2) of the act provides that no company shall capitalize its profit or reserves for issuance of fully paid up shares/

SEBI Guidelines. Subject to the provisions of Companies Act, 2013, listed companies intending to issue bonus shares to its shareholders must comply with SEBI guidelines which are contained in the Chapter XV of SEBI (Disclosure & Investor Protection).

Consequences of bonus issue

Ideally, when a company issues bonus shares, the market price of the shares should fall proportionately to the new shares issued as the total number of shares of the company floating in the market increases. This may not be the case in reality as the share prices increase after the announcement of bonus issue. This happens mainly because of the common understanding among investors that a bonus issue points towards the management’s confidence in the future growth prospects of the company. It is also seen as being indicative of the good financial position of the company and enhances the investors’ confidence in the management.

It is generally observed that as soon as a bonus issue is declared, the market price of the company’s shares increases at a rapid rate, even though the net worth of the company remains the same (since no cash or other resources are collected or paid on a bonus issue). The question which arises at this stage is whether such investor optimism/ enhancement in the market value of the shares after the bonus issue is subsequently justified by an actual improvement in the financial position of the company in the medium/long term (as disclosed in its audited financial statements), or only attributable to market speculation driven solely by the objective of earning short-term profits.