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What is Bonus Issue?
Bonus Issue is a way of giving bonus shares or free shares by the company to its existing shareholders. The bonus shares are distributed to the shareholders according to the number of shares they hold.
During a stock dividend, the company distributes the bonus shares in a specific percentage like 5% or 10% but during the bonus issue company gives bonus shares in a specific ratio (as during the rights issue) like 4:1 and 2:5, etc.
Let’s understand, how bonus shares are distributed during bonus issues and stock dividends.
In both corporate actions, i.e. stock dividend and bonus issue, the company is giving the bonus shares to the shareholders but the only difference is that in stock dividend, free shares are distributed as a percentage, and in bonus issue of shares, as a ratio.
Purpose of Bonus Issue
One can ask this question, ‘why bonus shares are issued?’
The company normally distributes cash dividends as a reward to its shareholders. But many a time when a company has a shortage of funds or is short of cash and the shareholders expect a regular income from the company, then it decided to give bonus shares through bonus issue. Later the shareholders can sell these received bonus shares and meet their liquidity needs.
Here, a question arises: ‘Does a company always issue bonus shares instead of cash dividends?’ The answer is no. There may be cases when a company will have good reserves, and it has still decided to issue bonus shares because a bonus issue is also a way of rewarding the shareholders for their trust in the company.
Knowing the important bonus issue dates will help us to understand the procedure of the bonus issue. So, let’s discuss the important bonus issue dates:
- Announcement Date: On this date, the company announces that it will distribute the bonus shares. On this date company also announce the ex-bonus date, record date, and when it will credit the shares to the account of shareholders. The announcement date is also known as the Distribution date.
- Ex-Bonus Date: If you want to get the bonus shares of the bonus issuing company, then you must buy the shares of that company before this date.
- Record Date: You must have shares in your demat account on this date to be eligible for the bonus shares. This date falls a day or two after the ex-dividend date but in most cases, it is one day.
The clearing and settlement process takes 'T+2' days (which is 'Trading date + 2 working days', for example if you buy shares today you will get delivery of shares the day after tomorrow) and mostly ex-bonus date falls 1 day before the record date; Therefore, if you buy shares of a bonus issuing company even one day before the ex-bonus date, you will have the shares in your account on the record date, but if you buy the shares on or after the ex-bonus date, you will not be entitled to the dividend. as you will not be holding the shares as on the record date.
- Credit Date: The date on which the bonus shares get credited to your demat account.
Once the company has determined the shareholders eligible to receive the bonus shares as on the record date, it proceeds to allot ISIN (International Securities Identification Number) to the bonus shares. Upon allotting ISINs to all bonus shares, the company credits the bonus shares to the demat accounts of its shareholders within 15 days.
To understand the bonus issue’s effect on share price, you need to know about the market capitalization. So that you can understand this concept completely.
The market capitalization before and post-bonus issue remains the same i.e. market cap doesn’t change. When the number of outstanding shares increases, on the other hand, the share price decrease with a specific value so that the market cap remains the same.
As the market cap of a company remains the same after the bonus issue of shares, in the same manner, the total worth of the investment by a shareholder of that company also remains the same before and after the bonus issue.
Let’s say that an investor bought 100 shares of the bonus-issuing company before the ex-bonus date at the market price of Rs 50 per share to get the bonus shares. So, the total investment he did in the company is Rs 5000 (100 shares * Rs 50/ share). Surely, the share price will decrease post-bonus issue.
Does it mean the value of his/her investment which is Rs 5000 will decrease and if your answer is yes, then what is the sense of investing in a bonus issue if you would book a loss after its completion?
Well, the share price will decrease from Rs 50 to a certain value on the other hand – like the number of outstanding shares in the formula of market capitalization – the number of shares will increase from 100 to a certain value and this is how the total value of investment (no. of shares * share price) will remain same.
Now, let’s find out, to what specific value, the share price will decrease and the number of shares will increase. Take the example of the 4:1 bonus issue.
Conclusion
Bonus issue of shares is a corporate action where the company issues bonus or free shares to its shareholders. Bonus shares are distributed in bonus ratios like 1:1 and 2:1 etc. A company can also issue free shares through another corporate action called stock dividend where the shares are given in the form of percentages.
After the bonus issue, the number of outstanding shares of a company increase, and the share price decrease.
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