Bonus shares are free shares issued to the shareholders out of accumulated reserves. These are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These reserves are created by the company out of profits and thereafter they are capitalized by the issue of bonuses, shares. These are the company’s accumulated earnings which are not given out in the form of dividends but are converted into free shares. This is also known as a capitalized profit. Bonus issues are given to shareholders when companies are short of cash and shareholders expect a regular income. The company cannot charge the shareholders for the issue of the bonus shares. It is basically rewarding the current shareholders with additional shares without any extra cost. They are often given out instead of dividends.
The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of a number of shares held to the number of shares outstanding. A company may decide to distribute further shares as an alternative to increasing the dividend payout. Companies issue bonus shares to encourage retail participation and increase their equity base.
Issuing bonus shares does not involve cash flow. It increases the company’s share capital but not its net assets. These are issued as new or additional shares, free of cost and in proportion to the shares and dividends held by the shareholder. These shares are provided to the shareholders out of the accumulated earnings or profits of a company, so it is also known as the capitalization of the profits.
The most prominent reasons for this, which are as follows:
- Issuing of the additional shares is one of the ways of showing appreciation to the investors.
- When the bonus shares are issued by the company, then leads to an increase in the number of outstanding shares.
- Whenever a company decides to issue bonus shares, then the prices of the stocks fall to a reasonable range.
Advantages of Bonus Shares
- An investor is required to pay any tax on the bonus shares.
- If the shareholders want, then they can convert the bonus shares into cash by selling them at a higher price.
Disadvantages of Bonus Shares
- If there is any fluctuation in the dividend rate, then it can lead to a decrease in the share prices.
- It leads to an increase in speculation, which is not good for the company.