Bonus shares: Meaning, Criticisms & Real-World Uses

What Are Bonus Shares?

Bonus shares are additional shares issued by a company to its existing shareholders without any additional cost. This corporate action falls under the broader category of corporate actions and is a way for a company to distribute its accumulated earnings or reserves to investors, rather than paying a cash dividend. While the number of shares an investor holds increases, the overall market capitalization of the company theoretically remains the same, leading to a proportionate decrease in the share price.

History and Origin

The practice of issuing bonus shares evolved as companies sought ways to reward shareholders and retain cash within the business for growth and expansion. Instead of depleting cash reserves through dividend payouts, bonus share issues allow companies to capitalize on their retained earnings or securities premium account by converting them into equity capital. This mechanism essentially converts a company's profits into share capital, increasing the number of outstanding shares while maintaining the same shareholder equity. For instance, in October 2024, Reliance Industries announced a 1:1 bonus share issue, meaning shareholders received one additional bonus share for every share they owned, a move that saw its stock price respond accordingly on the stock exchange.⁹, ¹⁰, ¹¹

Key Takeaways

Bonus shares are additional shares issued to existing shareholders free of charge.
They are a way for companies to capitalize reserves without a cash outflow.
While the number of shares increases, the overall value of an investor's holding typically remains the same immediately after the issue.
Bonus issues can increase the liquidity of a company's shares in the market.
Issuing bonus shares does not dilute the proportionate ownership of existing shareholders.

Formula and Calculation

The calculation for bonus shares involves determining the ratio at which new shares are issued. If a company announces a 1:1 bonus issue, it means for every one share an investor holds, they will receive one additional bonus share.

The formula for the new number of shares and the theoretical ex-bonus price is as follows:

\text{New Shares} = \text{Old Shares} \times \left(1 + \frac{\text{Bonus Ratio Numerator}}{\text{Bonus Ratio Denominator}}\right)

\text{Theoretical Ex-Bonus Price} = \frac{\text{Current Market Price}}{\left(1 + \frac{\text{Bonus Ratio Numerator}}{\text{Bonus Ratio Denominator}}\right)}

Where:

Old Shares represents the number of shares held by the investor before the bonus issue.
Bonus Ratio Numerator is the number of bonus shares received (e.g., 1 in a 1:1 ratio).
Bonus Ratio Denominator is the number of existing shares required to receive the bonus (e.g., 1 in a 1:1 ratio).
Current Market Price is the share price before the bonus announcement.

It's important to note that the face value per share might also be adjusted in conjunction with or independently of a bonus issue.

Interpreting Bonus Shares

When a company announces bonus shares, it's generally seen as a positive signal to the market, indicating the company's financial strength and confidence in future profitability. Although the total value of an investor's holding does not change immediately, the increased number of shares can lead to greater trading volume and improved liquidity. The theoretical drop in share price post-bonus issue can also make the shares more accessible to a wider range of investors, particularly retail investors, potentially boosting demand. For investors, understanding the implications on per-share metrics, like earnings per share (EPS), is crucial as these will decrease proportionally, while total earnings attributable to their holding remain the same. This can be assessed by reviewing the company's financial statements.

Hypothetical Example

Consider an investor, Sarah, who owns 100 shares of ABC Corp, trading at $50 per share. The total value of her investment is $5,000.

ABC Corp announces a 1:1 bonus share issue. This means for every one existing equity share Sarah holds, she will receive one additional share.

Old Shares: 100
Bonus Ratio: 1:1
New Shares Calculation: $\text{New Shares} = 100 \times \left(1 + \frac{1}{1}\right) = 100 \times 2 = 200 \text{ shares}$
Theoretical Ex-Bonus Price Calculation: $\text{Theoretical Ex-Bonus Price} = \frac{\$50}{\left(1 + \frac{1}{1}\right)} = \frac{\$50}{2} = \$25 \text{ per share}$

After the bonus issue, Sarah will own 200 shares, and the theoretical price per share will be $25. The total value of her investment remains $200 \text{ shares} \times $25/\text{share} = $5,000$, the same as before the bonus issue.

Practical Applications

Bonus shares are a common strategy employed by companies for several reasons:

Rewarding Shareholders: It's a way to give back to investors without a cash outflow, which can be particularly useful for growth-oriented companies that prefer to reinvest profits.
Improving Liquidity: By increasing the number of outstanding shares and lowering the per-share price, bonus issues can make shares more affordable and liquid, attracting a broader investor base.
Signaling Financial Strength: A company issuing bonus shares often signals robust reserves and a healthy book value, indicating management's confidence in future earnings.
Capitalizing Reserves: From an accounting perspective, bonus shares allow a company to convert accumulated profits or retained earnings into share capital, reflecting a more permanent capital structure.
Tax Implications: For shareholders, bonus shares themselves are generally not taxable at the time of receipt in many jurisdictions, unlike cash dividends. However, when these bonus shares are later sold, any capital gains realized will be subject to taxation. The Internal Revenue Service (IRS) provides detailed guidance on the taxation of dividends, which can include stock distributions under certain circumstances.⁸ Public companies engaging in such corporate actions must also adhere to regulations set by bodies like the U.S. Securities and Exchange Commission (SEC), which oversees reporting requirements for changes in outstanding shares. Regulations like 17 CFR § 240.16a-9 specifically address stock splits and stock dividends.
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Limitations and Criticisms

While bonus shares are often viewed favorably, they have limitations:

No Immediate Increase in Shareholder Wealth: The total market value of an investor's holding does not change immediately after a bonus issue, as the share price adjusts proportionally. This can lead to a misperception among some investors who anticipate an immediate increase in wealth.
No Cash Inflow: Unlike cash dividends, bonus shares do not provide shareholders with direct cash. Investors seeking income from their investments may prefer cash distributions.
Impact on Per-Share Metrics: Financial metrics such as earnings per share (EPS) and dividends per share will decrease proportionately, as the same total earnings are spread over a larger number of shares. Investors must adjust their analysis of these metrics accordingly.
Market Perception: While often positive, a bonus issue might be misinterpreted if the underlying financial health of the company is not strong, or if it is perceived as an attempt to artificially inflate share volume without genuine growth prospects.
Regulatory Scrutiny: Corporate actions like bonus issues, particularly in conjunction with other changes, are subject to regulatory oversight to ensure fair practice and transparency. For instance, the SEC issues investor bulletins to help shareholders understand various corporate actions, including those affecting share structure.
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Bonus Shares vs. Stock Split

Bonus shares and a stock split are both corporate actions that increase the number of shares outstanding and decrease the per-share price, but they differ in their accounting treatment and legal implications.

Feature	Bonus Shares	Stock Split
Accounting	Involves capitalizing reserves (like retained earnings or securities premium account) into share capital.	Does not involve any transfer from reserves to capital. It is simply a division of existing shares into a larger number of shares, with a proportionate reduction in the face value per share.
Share Capital	Increases the company's paid-up equity capital.	Does not change the company's paid-up share capital; it only changes the number of shares and their nominal value.
Regulatory View	Often seen as a distribution of capitalized profits.	Seen as a technical adjustment to the share structure aimed at making shares more affordable and liquid. The SEC, for example, clarifies that a stock split does not dilute ownership interests. ³, ⁴
Example	A 1:1 bonus issue means for every 1 share held, 1 new bonus share is issued.	A 2-for-1 stock split means for every 1 share held, it becomes 2 shares. The principle is similar: an investor owning 100 shares at $100 per share would have 200 shares at $50 per share after a 2-for-1 split, maintaining the total value. ¹, ²

While both result in more shares at a lower price per share, the key distinction lies in how they are recorded on the company's balance sheet and the source from which the additional shares are issued.

FAQs

1. Are bonus shares the same as dividends?

No, bonus shares are not the same as cash dividends. While both are ways a company can reward shareholders, cash dividends involve a direct payment of money, whereas bonus shares involve issuing additional shares of stock. Bonus shares don't reduce the company's cash reserves, as they are issued by capitalizing existing reserves or profits.

2. Do I have to pay for bonus shares?

No, bonus shares are issued free of cost to existing shareholders. They are a form of non-cash distribution.

3. How do bonus shares affect the stock price?

Immediately after the announcement of bonus shares, the stock price tends to adjust downwards proportionally to the bonus ratio. For example, if a company announces a 1:1 bonus issue, its share price will theoretically halve, because twice as many shares now represent the same underlying company value. The total value of an investor's holdings remains the same, but it is distributed across more shares. The share price typically goes ex-bonus on the ex-dividend date.

4. What is the record date for bonus shares?

The record date for bonus shares is the specific date set by the company's board of directors on which a shareholder must be registered in the company's books to be eligible to receive the bonus shares. Only shareholders whose names appear in the company's register on this date will be entitled to the bonus issue.

5. Are bonus shares taxable?

In many jurisdictions, the receipt of bonus shares themselves is not considered a taxable event at the time of issue. However, when these bonus shares are eventually sold, any profit realized from the sale (the difference between the sale price and the adjusted cost basis of the shares) would be treated as a capital gain and would be subject to taxation according to the applicable tax laws.