Bonus Shares – Meaning, Types & Advantages of Bonus Shares

Bonus shares are the additional shares that a company gives to its existing shareholders on the basis of shares owned by them. These are issued to the shareholders without any additional cost.

What are Bonus Shares?

Bonus shares are additional shares that current shareholders receive at no extra cost, depending on how many shares they already own. These are the company's total profits that are turned into free shares rather than distributed as dividends.

The fundamental idea underlying bonus shares is that as the ratio of owned to outstanding shares remains constant, the total number of shares will rise. If a corporation announces a 4:1 incentive, for example, Investor A, who owns 200 shares of the company, will receive four shares for free. He will receive 800 shares free of charge, bringing his total holdings to 1,000 shares.

Bonus shares are issued by businesses to boost their stock base and promote retail engagement. It becomes challenging for new investors to purchase shares in a company when the price per share is high. The price per share decreases as the number of shares increases. However, even if bonus shares are announced, the total capital remains unchanged.

Who is Eligible for Bonus Shares?

Bonus shares can be awarded by the corporation to shareholders who held shares prior to the ex-date and record date. The T+2 rolling system, in which the record date is two days behind the ex-date, is used in India to deliver shares.

In order to be eligible for bonus shares, shareholders must buy their shares before the ex-date. If they buy on the ex-date, the firm will not provide them with ownership of the shares. After the bonus shares are assigned and a new ISIN (International Securities Identification Number) is assigned, the shares are transferred within 15 days to the shareholder's account.

How Do Bonus Shares Work?

Companies issue bonus shares by capitalising their reserves, usually when they want to reward shareholders but prefer to retain cash for operations. For example, in a 1:2 bonus issue, a shareholder receives one bonus share for every two held. While the total number of shares increases, the overall value of holdings remains unchanged as the stock price adjusts proportionally. Bonus shares do not involve any cash outflow and are often viewed positively by the market, as they reflect a company’s confidence in future profits. These shares are credited directly to the investor's demat account.

Types of Bonus Shares

There are primarily two types of bonus shares: fully paid and partly paid bonus shares. Fully paid bonus shares are issued from the company’s free reserves or retained earnings. These are allotted to shareholders without any additional payment and are equivalent in status to existing shares. Most bonus issues in India fall under this category.

Partly paid bonus shares are rarely issued today. In this case, bonus shares are given on partly paid shares to make them fully paid without asking shareholders for the remaining payment. This is done by utilising the company’s reserves to pay the outstanding balance on partly paid shares.

Fully paid shares are more common and preferred, as they are simpler to issue and manage.

Why Do Companies Issue Bonus Shares?

Bonus shares are issued by a company when it is unable to pay a dividend to its shareholders due to a shortage of funds in spite of earning good profits for that quarter. In such a situation, the company issues bonus shares to its existing shareholders instead of paying dividends. These shares are given to the current shareholders on the basis of their existing holding in the company. Issuing bonus shares to the existing shareholders is also called capitalisation of profits because it is given out of the profits or reserves of the company.

Calculation of Bonus Shares

Existing shareholders receive the bonus shares based on their current stake in the company. Suppose a shareholder holds 1,000 shares of the company. Now when the company issues bonus shares, they will receive 500 bonus shares (1,000 * 1/2 = 500). When the company issues bonus shares, the term “record date” is used along with it.

What Is Record Date?

Record date is a cut-off date set by the company. If investors own the shares of the company on this cut-off date, they are eligible to receive the bonus shares. The record date is set by the company so that they can find the eligible shareholders and distribute bonus shares to them.

Advantages of Bonus Shares

• They receive bonus shares without having to pay any tax, making it a tax-efficient benefit.
  
• Long-term shareholders are rewarded as their holdings increase without any additional investment.
  
• With more shares held, investors stand to receive higher dividends in the future if the company declares them.
  
• Bonus shares signal financial stability and confidence from the company, boosting investor trust.
  
• The increase in the number of shares enhances liquidity, making it easier to buy or sell shares.
  
• Market perception improves, as bonus shares are often seen as a commitment to long-term growth.
  

For companies:

• Companies can reward shareholders while preserving cash for future business needs.
  

• Issuing bonus shares reflects management’s confidence in ongoing profitability and performance.
  

• It helps build and maintain strong relationships with existing shareholders.
  

• An increase in the number of outstanding shares boosts liquidity and trading volumes.
  

• Enhanced liquidity often results in better price discovery and stability in the market.
  

• A larger issued share capital can create the perception of a stronger and more stable company, attracting institutional investors.
  

Disadvantages of Bonus Shares

Investors:

• Although the number of shares increases, the overall value of holdings remains the same as the share price adjusts proportionally.

• Bonus shares do not offer immediate monetary gain, unlike dividends which provide cash payouts.

• The increase in outstanding shares may dilute earnings per share (EPS), affecting key financial ratios.

• If the company performs poorly in the future, holding more shares may not benefit the investor.

• There may be confusion among retail investors regarding the actual benefit of bonus shares, as they do not increase wealth directly.

For companies

• Issuing bonus shares reduces the company’s free reserves, which could otherwise be used for expansion or contingencies.

• It may create expectations among shareholders for regular bonus issues, adding pressure on management.

• An increase in outstanding shares could lead to reduced EPS, possibly affecting stock valuation.

• The administrative work involved in issuing bonus shares and updating shareholder records adds to operational costs.

• If not backed by strong fundamentals, bonus issues might mislead the market and create unrealistic optimism.

• Overuse of bonus issues may dilute the long-term value of equity for both the company and its shareholders.

How Bonus Share Different from a Stock Split?

Bonus shares and stock splits both increase the number of shares outstanding, but they work in different ways and have different purposes.

By capitalising the company's reserves, bonus shares are distributed to current shareholders at no cost. The company's share capital rises while reserves fall, but the share price varies correspondingly. Bonuses are an indication of future earnings optimism.

Stock splits lower the face value of each existing share, dividing it into smaller units. Only the number of shares rises; the total share capital stays the same. The primary benefits of stock splits are increased affordability and liquidity.

Conditions for Issue of Bonus Shares

The issue of bonus shares must be recommended by the resolution of the Board of Directors. Also, this recommendation must be later approved by the shareholders of the company in the general meeting. The Controller of Capital Issues must give permission for the issue. The aforementioned are conditions that a company must fulfil to issue bonus shares. To be eligible for the different types of bonus shares, investors must hold the shares of the company in the demat account.

Conclusion

Bonus shares serve as an effective tool for companies to reward loyal shareholders while retaining capital for growth. They reflect financial strength and boost investor confidence without immediate cash outflows. However, investors must understand that bonus shares do not increase the intrinsic value of their holdings and may lead to earnings dilution. For companies, while bonus issues can enhance market perception and liquidity, they also come with operational and strategic implications. Thus, both investors and companies should view bonus shares as part of a broader financial and investment strategy, not just a short-term benefit.