What is a Bonus Issue
A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of free additional shares to existing shareholders. A company may decide to distribute further shares as an alternative to increasing the dividend payout. For example, a company may give one bonus share for every five shares held.
BREAKING DOWN Bonus Issue
Bonus issues are given to shareholders when companies are short of cash and shareholders expect a regular income. Shareholders may sell the bonus shares and meet their liquidity needs. Bonus shares may also be issued to restructure company reserves. Issuing bonus shares does not involve cash flow. It increases the company’s share capital but not its net assets.
Bonus shares are issued according to each shareholder’s stake in the company. For example, a three-for-two bonus issue entitles each shareholder three shares for every two they hold before the issue. A shareholder with 1,000 shares receives 1,500 bonus shares (1000 x 3 / 2 = 1500).
Advantages and Disadvantages of Issuing Bonus Shares
Companies low on cash may issue bonus shares rather than cash dividends as a method of providing income to shareholders. Because issuing bonus shares increases the issued share capital of the company, the company is perceived as being bigger than it really is, making it more attractive to investors. In addition, increasing the number of outstanding shares decreases the stock price, making the stock more affordable for retail investors.
However, issuing bonus shares takes more money from the cash reserve than issuing dividends does. Also, because issuing bonus shares does not generate cash for the company, it could result in a decline in the dividends per share in the future, which shareholders may not view favorably. In addition, shareholders selling bonus shares to meet liquidity needs lowers shareholders' percentage stake in the company, giving them less control over how the company is managed.
Stock Splits and Bonus Shares
Stock splits and bonus shares have many similarities and differences. When a company declares a stock split, the number of shares increases, but the investment value remains the same. Companies typically declare a stock split as a method of infusing additional liquidity into shares, increasing the number of shares trading and making shares more affordable to retail investors.
When a stock is split, there is no increase or decrease in the company's cash reserves. In contrast, when a company issues bonus shares, the shares are paid for out of the cash reserves, and the reserves deplete.