Understanding Bonus Issues in Finance

A bonus issue, often called a scrip issue or a capitalization issue, is a process where a company distributes additional shares to its existing shareholders free of charge. It’s not a fundraising exercise; the company doesn't receive any new capital. Instead, it's a redistribution of the company's existing reserves and surplus into equity capital.

Why Companies Issue Bonus Shares

Companies undertake bonus issues for several reasons. Primarily, it improves the liquidity of the shares in the market. By increasing the number of outstanding shares, the price per share typically decreases proportionally, making them more accessible to smaller investors. This can lead to greater trading volume and potentially improve the company's overall market visibility.

Another reason is to signal confidence to the market. A company issuing bonus shares demonstrates that it has sufficient accumulated profits and reserves. This can be interpreted as a positive sign, indicating financial strength and future growth potential, potentially boosting investor sentiment.

Bonus issues can also help to bring the market price of a company's shares within a more desirable trading range. Sometimes, a company's share price becomes excessively high, making it less attractive to retail investors. A bonus issue effectively splits the existing shares, reducing the price per share and encouraging broader participation.

Finally, it can be a way to capitalize reserves without actually distributing cash dividends. While dividends are generally preferred by investors, they attract dividend distribution tax. Bonus issues, while diluting the ownership percentage slightly, allow the company to retain cash within the business for investment and growth.

Impact on Shareholders

While shareholders receive additional shares, it's crucial to understand that a bonus issue doesn't increase their overall investment value. The total market capitalization of the company remains the same, and the value of each individual share is reduced proportionally. The shareholder now owns more shares, but each share represents a smaller fraction of the company's ownership.

For example, if a shareholder owns 100 shares of a company trading at $100 per share, and the company issues a 1:1 bonus (one bonus share for every share held), the shareholder will then own 200 shares. However, the share price will likely adjust to around $50 per share, keeping the total value of the shareholder's investment at approximately $10,000 (before considering market fluctuations).

Conclusion

Bonus issues are a corporate action that can benefit both the company and its shareholders. They improve liquidity, signal financial strength, and bring share prices to more accessible levels. While bonus shares don't directly increase shareholder wealth, they can indirectly benefit shareholders through increased trading volume and potential future growth driven by the retention of profits within the company.