Bonus shares are additional shares allocated to existing shareholders without getting payment from them. They are allotted by capitalising the reserves.
Bonus issues are termed as capitalisation of the company’s profits as the company’s profits are converted into share capital.
A company may decide to distribute further shares as an alternative to increasing the dividend payout.
When a company has accumulated a large fund out of profits, more than its needs, the directors may decide to distribute a part of it amongst the shareholders in the form of a bonus.
Reasons for Issuing Bonus Shares
1. To increase the number of outstanding shares to facilitate more active trading.
2. Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened and they can reasonably look for an increase in total dividend.
3. Improves the prospects of raising additional funds.
4. The bonus issue brings the share price to a more ‘reasonable’ range for some investors.
5. Share capital base increases and the company is seen as bigger by the investing public.
Advantages of Bonus Issues
Retention of managerial control: Since bonus shares are issued to the existing shareholders to their current holdings, there is no threat of dilution of managerial control over the company, as opposed to a new issue of shares where new investors may come in.
Tax benefits: Bonus shares issued to shareholders are not taxed as dividends are.
Positive perception: Bonus issues are perceived positively by the market and this tends to create greater demand for the company’s shares
Differences between stock splits and bonus issues
1. During a bonus issue, the par value of the share remains unchanged while the par value of a share is reduced during a stock split.
2. There is capitalisation of reserves during bonus issues while there is no capitalisation of reserves during stock splits.
Scrip Issue
Shareholders are able to choose whether to receive a cash dividend or shares.
It is a way for a company to save money but still pay a ‘dividend’
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