Bonus shares are the company’s accumulated earnings which are converted into free/additional shares that are passed on to the current shareholders by the stake held by each of them without charging any additional cost.
Bonus shares are also known as scrip dividends. These shares are distributed free on cost on a fully paid basis to the current shareholders. Issuing of bonus shares is called a bonus share issue or bonus issue. These shares are issued due to the following reasons:
To make use of the company’s retained earnings.
To convert the share premium account, or
To distribute treasury shares
Example: Say, you hold 20 shares of X company. Now, the company chooses to issue bonus shares to all its current shareholders including you. And, say it decides that for every 5 shares, you will be given one bonus share free. So, you get 4 bonus shares in total.
It won’t be wrong to say that it is like a reward given by a company to its current shareholders. As per the Company Act, 2013, the bonus issue must be fully paid to the shareholders. Some companies, which have a low amount of cash prefer to issue bonus shares rather than paying dividends.
Though with bonus shares, the number of shares held by each goes up, but the ratio of shares held by each investor remains as it is. Hence, bonus shares are just a replacement of dividends and are usually followed when the company has a good corpus of financial reserves.
Benefits of issuing bonus shares
Bonus shares offer tremendous benefits by adding on to the total number of shares in the market. They do lead to a phenomenon which is popularly called ‘dilution of equity.’ Suppose, a company had 500 shares existing in the market, and now it has released 200 bonus shares, so the total number of shares of this company in the market is 700.
Theoretically speaking, the stock price should reduce due to the increased number of shares, but this may not happen practically.
When can the bonus shares be issued?
The bonus shares can be issued under the following conditions:
They can be issued only if the Articles of Association of the company authorizes a bonus issue.
These shares are released on recommendations of BOD of company and are sanctioned by shareholders themselves.
The company issuing bonus shares must abide by the guidelines issued by SEBI.
Only fully paid-up bonus shares are to be issued, as if partly paid-up ones are released then the shareholders become liable to bear the part value of the shares, which is not fair.
Stock split and bonus shares
Stock split and bonus shares are similar in many ways. When you hear a company declaring a stock split, then the number of shares increase but the company’s cash reserve remains the same. On the contrary, when bonus shares are issued then again the number of shares goes up, but the company’s cash reserves deplete.