Understanding Bonus Issue in Corporate Finance

Understanding Bonus Issue in Corporate Finance

This article aims to elucidate the concept of bonus issues, their mechanics, implications, and the rationale behind their deployment.

What is a Bonus Issue?

A bonus issue, also known as a scrip issue or capitalization issue, involves the issuance of additional shares to existing shareholders without any consideration in cash. Essentially, the company converts its reserves or profits into share capital, increasing the total number of outstanding shares. Despite the increase in shares, the proportional ownership of each shareholder remains unchanged.

In the realm of corporate finance, bonus issues are a strategic tool employed by companies to reward existing shareholders while conserving cash. This mechanism holds significance in the financial landscape, influencing investor sentiment and company valuation.

Why do companies issue bonus shares?

Companies resort to bonus issues for several reasons, including:

1. Rewarding Shareholders: Bonus issues serve as a means to reward existing shareholders by enhancing their stake in the company without necessitating any cash outflow.
2. Improving Liquidity: Increasing the number of outstanding shares through bonus issues enhances liquidity in the market, potentially attracting more investors.
3. Signaling Positive Outlook: A bonus issue often conveys a positive signal about the company’s financial health and future prospects. It reflects confidence in the company’s ability to generate sustainable earnings and create value for shareholders.
4. Conserving Cash: By utilizing retained earnings or reserves for bonus issues, companies can conserve cash for strategic investments, debt repayment, or other operational requirements.

Implications of Bonus Issues

Bonus issues entail several implications for various stakeholders:

1. Shareholders: Existing shareholders benefit from bonus issues through increased ownership without dilution of control. However, the market price per share typically adjusts post-bonus issuance to reflect the increased supply of shares.
2. Investors: Bonus issues may attract investors seeking to capitalize on the perceived positive signal and potential price appreciation. However, investors must assess the underlying fundamentals and long-term prospects of the company beyond the immediate market reaction.
3. Regulatory Compliance: Companies must adhere to regulatory frameworks governing bonus issues, ensuring transparency, fairness, and compliance with relevant laws and regulations.

Example scenario

Let’s consider a hypothetical example of a bonus issue to illustrate how it works:

The board of Company XYZ announces a record date (shareholders who are registered in the company’s books as of this date will be eligible to receive the bonus shares.); let’s say its set as July 1, 2024.

If a shareholder holds 100 shares of Company XYZ on or before July 1, they will receive additional shares as per the bonus issue ratio.

Let’s assume the bonus issue ratio is 1:1, meaning for every one existing share held, the shareholder will receive one bonus share. If an investor holds 100 shares before the record date, they will receive an additional 100 shares as a bonus.

Who is eligible for Bonus Shares?

Shareholders who own the company’s shares before the ex-date and record date are eligible to receive bonus shares from the company.

In India, the T+2 rolling system are set for the delivery of the shares, wherein the record date is two days behind the ex-date.

Once a new ISIN (International Securities Identification Number) is allotted for the bonus shares, the bonus shares will be credited to the shareholder’s account within 15 days of time.