Effect of Bonus Issues on Shareholder Value and Stock Prices

INTRODUCTION

The stock market is an intricate ecosystem where companies and investors engage in buying and selling shares. Bonus issues are a common phenomenon in this landscape. A bonus issue refers to the practice of a company issuing additional shares to its existing shareholders free of charge. Bonus issue, also known as scrip dividends or capitalization issues, play a significant role in the stock market and can have a substantial impact on shareholder value and stock prices. In this article, we will explore the effect of bonus issue on these key aspects of the financial market.

UNDERSTANDING BONUS ISSUES

Bonus issue are primarily aimed at rewarding existing shareholders and can be seen as a gesture of goodwill from the company. When a company issues bonus shares, it increases the total number of shares outstanding without altering the company’s underlying value. Shareholders receive additional shares in proportion to their existing holdings. 

The decision to issue bonus shares is influenced by various factors. Companies may choose to issue bonus shares to capitalize on their retained earnings or accumulated reserves. Additionally, bonus issue can be used as a strategic move to improve liquidity and increase market participation. The mechanics of bonus issue involve adjusting the share capital and transferring amounts from reserves to share capital.

Why do Companies Issue Bonus Share 

Companies issue bonus shares to distribute free shares to the existing shareholders as a reward for being long-term investors. This approach eliminates the need for the company or the business to allocate extra assets because it uses its accumulated reserves. By transforming these reserves into share capital, the company improves its financial structure while preserving its cash assets. This method is especially useful for companies with huge numbers of assets but less liquid assets. 

As a result of issuing bonus shares, the number of outstanding shares in the market grows. This rise in the supply of shares improves liquidity, which means more shares are accessible for trade. This increased liquidity may attract more retail investors who were previously turned off by the stock’s higher price. 

How are Bonus Shares Taxed? 

Bonus shares are generally not considered taxable income for shareholders because they do not result in the receipt of cash or can be seen as tangible assets in the books. Instead, they represent a distribution of the company’s extra stock among its current shareholders.

However, tax concerns are taken into account when the shareholder decides to sell their share. Any profits made from the selling of bonus shares may be liable to capital gains tax (it includes all the profit combined from the shares). Capital gains tax is normally calculated on the difference between the selling price of shares and their initial purchase price or acquisition cost.

The actual tax slab of bonus share sales can vary greatly based on various aspects, including the shareholder’s holding duration, the tax regulations in their jurisdiction and that particular time, and whether the sale results in short-term or long-term capital gains. 

Advantage of Issuing Bonus Shares 

Issuing bonus shares provides companies with numerous benefits that improve their overall financial health and market reputation.

To begin, by giving bonus shares to current owners, the company increases shareholder value without depleting their cash reserves of their own. Bonus shares, which are effectively a transfer of reserves to share capital, enable corporations to use their clustered earnings to reward shareholders while maintaining liquidity for operational requirements, investments, or crises.

Issuing bonus shares also promotes stock market liquidity, more tradable shares are not in the market. With more shares available for trade, market activity increases, potentially improving price discovery and lowering bid-ask spreads. This increased liquidity makes it easier for investors to buy and sell shares, resulting in more efficient and seamless market transactions. 

Disadvantage of issuing bonus shares 

There are other disadvantages to issuing bonus shares. It may make present shareholders feel as if they own less of the company, reducing their power and the profits they receive from each share. It could also indicate that the company lacks sufficient funds to pay dividends or invest in growth without issuing bonus shares. So, while bonus shares can be beneficial in some situations, they can also have negative consequences for shareholders and the company’s reputation.

Stock Splits vs Bonus Shares 

Stock splits and bonus shares both increase the total number of tradable shares available in the open market but for distinct reasons. Stock splits are typically used to decrease the stock price’s appeal to investors while keeping the company’s value constant. Bonus shares, on the other hand, are treated as a gift to present shareholders and have no effect on the company’s overall worth.

Stock splits are intended to make trading the stock easier and attract more investors by making it affordable for retailers, whereas bonus shares are intended to reward existing shareholders without requiring the company to spend any additional funds. So, while both corporate actions increase the number of shares available, they are driven in different ways: Stock splits are designed to make trading easier and attract new investments, while bonus shares are a way for the company to thank its shareholders and keep its cash reserves intact.

IMPACT ON SHAREHOLDER VALUE

While bonus issues may be welcomed by shareholders, they have implications for shareholder value. One of the immediate effects of bonus issue is the increase in the number of shares held by each shareholder. This increase in shares can lead to dilution of ownership, as the proportionate ownership of each shareholder decreases. 

Furthermore, bonus issue can impact the company’s Earnings Per Share (EPS). With a higher number of shares in circulation, the earnings are distributed over a larger base, potentially reducing the EPS. This dilution effect on the EPS can influence investor perception and affect stock prices. 

Bonus issue can also have an impact on dividend payments. Companies may choose to distribute dividends based on the number of shares held by each shareholder. With an increase in the number of shares due to bonus issue, the dividend per share may decrease unless the company increases its overall dividend payout.

Also Read: Debentures Shares

IMPACT ON STOCK PRICES

The announcement of bonus issues often triggers reactions in the stock market. Initially, the market may respond positively to the news of bonus issue, perceiving it as a sign of the company’s financial health and future prospects. However, the subsequent impact on stock prices can be more complex. 

The increase in the number of shares due to bonus issues affects the supply and demand dynamics. With more shares available in the market, the supply increases. If the demand remains constant, this increased supply can put downward pressure on stock prices. However, if the bonus issues are well-received and boost investor confidence, the demand for the company’s shares may also increase, potentially offsetting the dilution effect. 

Psychologically, bonus issues can have an impact on investor sentiment. Investors may perceive bonus issues as a positive signal, reinforcing their confidence in the company’s growth potential. This positive sentiment can lead to increased buying activity and, subsequently, drive stock prices higher in the long term and vice versa.

FACTORS INFLUENCING SHAREHOLDER VALUE AND STOCK PRICES

1. Company’s financial performance:

The overall financial health of the company, its profitability, revenue growth, and future prospects play a crucial role in influencing investor sentiment and stock prices. 

2. Market sentiment and investor perception:

The market’s perception of the company, its management, and the industry it operates in can significantly impact investor behavior and stock prices. 

3. Industry trends and competition:

The broader industry trends, competitive landscape, and market conditions can influence how bonus issues are perceived and the subsequent impact on shareholder value and stock prices.

4. Economic conditions:

The prevailing economic conditions, such as interest rates, inflation, and overall market stability, can also influence investor sentiment and stock prices.

CONCLUSION

Bonus issues have a significant impact on shareholder value and stock prices. While they can be viewed as a way to reward shareholders and improve liquidity, their implications extend beyond the immediate announcement. Understanding the

mechanics of bonus issues, their impact on shareholder value, and the subsequent effect on stock prices are crucial for investors and companies alike. 

By considering the broader market dynamics, maintaining strong financial performance, and employing effective communication strategies, companies can navigate the complexities of bonus issues and maximize shareholder value in the long term.

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