What are Bonus Shares and how do they benefit shareholders?
Introduction – Bonus Share
The word bonus automatically signals something extra. Bonus shares are additional shares issued to existing shareholders of a company, usually at zero additional cost. The number of bonus shares issued depends on the number of shares a shareholder owns. Bonus shares are a part of the company's accumulated earnings which are converted into free shares and not given out in the form of dividends.
However, bonus shares do not increase the market value of an investor’s shareholding. The market price of shares adjusts in the same ratio in which the bonus shares are allotted. It reduces the price per share, making retail participation easier and increasing its liquidity. Hence, after a bonus issue, the total number of shares increases with a constant ratio of the number of shares held to the number of shares outstanding.
For example, if a company announces a bonus issue in a ratio of 3:1, it means that shareholders will get three bonus or free shares for every single share they hold. Thus, a shareholder holding 100 shares will get extra 3 shares for every share. That is a total of 300 shares for free, and his total holding will increase to 400 shares.
What is the Bonus Issue of Shares?
The bonus issue of shares is known by many names – bonus issue, scrip issue, and capitalisation issue. Bonus issue is a term used for the issue of free shares by companies to existing shareholders instead of cash dividends. The bonus issue of shares improves company credibility and increases the company’s share capital without increasing its net assets.
Benefits of Bonus Shares
Bonus shares not only prove advantageous for investors, but they also have plus points for companies as well.
For shareholders, the benefits are -
- Unlike dividends, investors don’t have to pay tax upon receiving bonus shares
- Free of cost
- Establishes trust in the company, hence the credibility of the stock is increased
- Enhances liquidity of the stock, helping better price discovery in the market
- Enhances company value
- Increases position and image in the market
- Builds strong company and investor relationships
- Inviting small and medium investors to invest in the stock
- More free-floating shares
- A cash dividend hands-off situation
Eligibility of Bonus Shares
It is important to understand who is eligible for the bonus shares in the stock market. Companies announce a record date for the bonus issue. All the shareholders of the company registered on the record date are eligible for the bonus shares.
Certain terms associated with the eligibility of bonus shares are ‘cum-bonus’ and ‘ex-bonus’. Cum-bonus are the eligible shares present between the date of announcement of bonus shares and the record date. Ex-bonus are the shares purchased post the ‘ex-date’.
The Ex-date is two days ahead of the record date. To be eligible for the bonus issue, investors must buy shares before the ex-date. It is because the T+2 settlement cycle is followed in India for the delivery of shares. If the shares are bought on or after the ex-date, they will not be credited into the demat account by the set record date, and buyers will not be eligible for the bonus shares.
Due to this, In India, the record date is set two days behind the ex-date. Only those shareholders will be eligible for bonus shares who acquire the stock prior to the ex-date.
Types of Bonus Shares
There are mainly two types of bonus shares – fully paid bonus shares and partly paid bonus shares.
Fully-paid bonus shares – These shares are when bonus shares are distributed at zero additional cost in relation to the shareholder’s shares in the company. They are issued out from many different sources, such as capital redemption reserves, profit and loss accounts, investment allowance reserves, security premium accounts, etc.
Partly-paid bonus shares – A partly-paid share is one for which only a partial payment of the issue price is made during the issue. The remaining amount is to be paid in instalments whenever the issuing company ‘calls’ for it. When the bonus is applied to convert these partly-paid shares into fully-paid shares without calling out the remaining amount, it is known as a partly-paid bonus share. They are also issued from various sources: investment allowance reserve, general reserve, development rebate reserve, etc.
Bonus shares are a strategic move that companies deploy in order to strengthen their equity base, increase retail participation and establish strong credibility. For shareholders, bonus shares are a way to gain a lot – a more liquid stock, increased investment, loan payments, collateral takeover, etc. For the company, bonus shares give a chance to increase the price per share without increasing assets, hence controlling the liabilities.
Q. What is a bonus share?
A. When companies issue additional shares to existing shareholders free of cost, they are known as bonus shares.
Q. Who is eligible to get bonus shares?
A. All shareholders of the company on the record date are eligible to receive bonus shares.
Q. What is the record date?
A. It is the date on which the company assesses its shareholder base for the purpose of issuing bonus shares.
Q. What is ex-date?
A. It is two days ahead of the record date. To be eligible for the bonus issue, investors must buy shares before the ex-date. It is because the T+2 settlement cycle is followed in India for the delivery of shares. If the shares are bought on or after the ex-date, they will not be credited into demat account by the set record date and buyers will not be eligible for the bonus shares.
Q. What are the two types of bonus shares?
A. Fully-paid bonus shares and partly-paid bonus shares.