What are Bonus Shares ? Is it in the Interest Of Shareholders ? DARK SIDE REVEALED 🙂



What are bonus shares?

When companies, despite being profitable, are unable to pay out their accumulated profits as dividends, they offer bonus shares to their existing shareholders. The bonus shares are offered to shareholders in proportion to their current holding levels. Companies that have dried up liquidity and are facing a shortage of cash in their balance sheet resort to bonus shares as a means to reward their shareholders.

Bonus shares are a medium through which companies convert their accumulated earnings into share capital. So, in a way issuing bonus shares saves the company from the liability to pay out dividends and helps shore up cash reserves. It’s important to understand that bonus shares don’t involve any cash flows in and out of the company. The net asset base of the company remains intact, and only the share capital is altered.

Why do companies issue bonus shares?

The last thing a company would want is the shareholders losing faith in the company. Non-payment of dividends out of accumulated profits on account of dried up cash balances is likely to result in something similar. To edge past this problem, shareholders are allotted bonus shares as a reward for investing in the company.

Issuing bonus shares also helps companies capitalize their reserves. Restructuring on the liability side occurs when the reserves are depleted and the equity capital rises equally. Since bonus shares are offered against the profits made by the company, the profit and loss account (forming part of the reserves) is reduced, and equity capital is increased. Bonus shares mark the steady income provided by the company to the shareholders, and in a way, it is a return delivered to the shareholders.

Benefits of bonus shares for investors

  1. Bonus shares don’t attract any tax implications when sold after holding them for longer than 12 mth. Also when the bonus shares are credited to the demat accounts of the shareholders, they don’t need to pay any taxes on the bonus shares received.
  2. Bonus shares are beneficial to investors who believe the company will flourish in the long run and bring manifold returns to their investment 

Features of bonus shares

1. Issue of bonus shares promotes the goodwill of the company among the shareholders and possible investors.

2. There is no change in the shareholding pattern post a bonus issue, as the allotment of bonus shares is done pro-rata
Since the company’s share price falls considerably post a bonus issue, it provides an opportunity for the retail investors to buy the company’s shares.

3. After a bonus issue, the share’s liquidity gets a considerable push by the increased number of outstanding shares.

4.Bonus shares can only be issued once a period of 12 mth has elapsed since the last issue for consideration. Also, only two bonus issues are allowed in five years. Otherwise, companies might misuse this opportunity to escape the liability of paying dividends

Disadvantages of bonus shares for investors ??

"The Hidden Truth"

When you see the bigger picture, you find that bonus shares do not award any real value to the shareholders. The value of the shares drop down in proportion to the bonus shares offered, and the net effect is nothing from the shareholders’ viewpoint. Also, from the company’s point of view, we find that the market capitalisation doesn’t change; it remains intact. 

Let’s understand this with an example. 

Suppose AB Pvt Ltd came up with a bonus issue of 1:2, that is for every two shares held in AB Pvt Ltd, the shareholders will receive one bonus share. 

The price of the share before the bonus issue was Rs 200. 

Mr X held 50 shares in AB Pvt Ltd, and his investment value totalled 50×200 = 10,000.

According to the terms of the bonus issue, Mr X received 25 more shares. Although as a result of the bonus issue, the share fell to Rs 133.34.

When we calculate the investment value of Mr X after the bonus issue, we find that it’s still the same as it was before the bonus issue. 

75 shares @ Rs 133.34 each = 10,000.

Hence, We observe that there is no real change in the portfolio value of the investor, which remains the same before and after the bonus issue.


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