Bonus Share

A bonus share refers to additional shares issued by a company to its existing shareholders without any additional cost, based on the number of shares already owned. It represents a method of capitalising a company’s accumulated reserves or surplus profits. The issue of bonus shares does not involve any inflow of fresh funds; rather, it converts part of the company’s reserves into paid-up share capital.

Background and Concept

Bonus shares are often distributed when a company has accumulated substantial profits and wishes to reward shareholders without distributing cash dividends. Instead of paying cash, the company issues additional shares, thereby increasing the shareholder’s total number of shares while the overall investment value remains unchanged initially. This process is also known as a capitalisation of profits.
For instance, a 1:1 bonus issue means that a shareholder receives one additional share for every share held. Similarly, a 2:1 bonus issue means two additional shares are issued for every existing share. Although the number of shares increases, the market price of each share typically adjusts downward in proportion, leaving the total market value largely unaffected in the short term.

Legal and Accounting Framework

The issue of bonus shares is governed by company law and stock exchange regulations in most jurisdictions. In India, the Companies Act, 2013 and the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations outline the conditions for bonus issues.
Key legal conditions include:

• Bonus shares must be issued only out of free reserves, securities premium account, or capital redemption reserve account.
• The company must not have defaulted on any statutory dues or fixed deposit obligations.
• The authorisation for a bonus issue must be contained in the Articles of Association.
• A resolution must be approved by the Board of Directors and, in some cases, by shareholders in a general meeting.

In accounting, the amount equivalent to the nominal value of bonus shares is transferred from reserves to the share capital account. This does not alter the total net worth but redistributes internal equity components.

Objectives and Rationale

The primary motives for issuing bonus shares include:

• Conservation of Cash: Enables a company to reward shareholders without reducing liquid resources.
• Market Appeal: Enhances the liquidity of shares in the market by reducing the per-share price, making them more affordable.
• Signal of Confidence: Suggests strong financial performance and management’s optimism about future prospects.
• Correction of Market Price: Helps maintain a price range conducive to active trading and wider participation.
• Psychological Effect: Shareholders perceive an increase in ownership, often improving market sentiment.

Types and Ratio of Bonus Issues

Bonus issues can be classified based on the source of funds and the proportion of distribution:

• Fully Paid Bonus Shares: Issued by capitalising free reserves or share premium, resulting in no further payment required from shareholders.
• Partly Paid Bonus Shares: Rarely used, where partly paid-up shares are converted into fully paid by capitalising reserves.

Common ratios include 1:1, 2:1, 3:2, etc., depending on profitability and reserve position.

Implications for Shareholders

While the number of shares increases after a bonus issue, the overall ownership proportion of each shareholder remains the same. The earnings per share (EPS) and book value per share decline proportionately because profits are now distributed among a larger number of shares. However, since no cash outflow occurs, shareholders’ wealth theoretically remains unaffected.
In practice, the perception of future growth may lead to temporary price adjustments. Investors often view bonus issues as positive signals of a company’s strength, and the market may respond favourably.

Advantages of Bonus Shares

• Improves Market Liquidity: With more shares in circulation and a lower per-share price, trading activity tends to increase.
• Boosts Investor Confidence: Acts as a reward to loyal shareholders, signalling management’s assurance of stability.
• Conserves Cash Reserves: Particularly useful for companies preferring to reinvest profits in operations rather than distribute dividends.
• Tax Efficiency: In many jurisdictions, receipt of bonus shares does not attract immediate taxation.

Disadvantages and Criticisms

• No Immediate Monetary Benefit: Shareholders do not receive cash and can only realise gains through sale of shares.
• Possible Dilution of EPS: Increased number of shares can lead to lower per-share earnings, potentially affecting valuation.
• Administrative Costs: Although non-cash, bonus issues entail procedural and compliance expenses.
• Temporary Market Reaction: In some cases, prices may fall more than proportionately, leading to short-term losses.

Bonus Share versus Stock Split

While both increase the number of shares, a bonus issue converts reserves into capital, whereas a stock split divides existing shares into smaller units without altering capital or reserves. For example, in a 1:2 split, each share of £10 becomes two shares of £5, while in a 1:1 bonus issue, reserves are capitalised to issue one additional share of £10.

Recent Trends and Notable Cases

Several listed companies across global markets, especially in India and the United Kingdom, frequently announce bonus issues to reward shareholders. Technology firms and consumer goods companies, which often generate strong cash flows, are notable for using this mechanism.
For instance, Indian conglomerates like Infosys, Tata Consultancy Services (TCS), and Reliance Industries Limited (RIL) have periodically issued bonus shares to maintain market participation and reflect sustained growth.