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What are the effects of issuing Bonus shares?
Bonus shares are additional shares issued by a company to existing shareholders based on their current stake in the company. When a company is unable to pay a dividend to its shareholders due to a lack of funds, it is common for them to issue Bonus shares. In such cases, instead of paying dividends, companies issue bonus shares to their existing shareholders. Investors do not have to pay any tax on the bonus shares they receive.
In some countries such as India, bonus shares are issued with a cash dividend to offer the shareholders some form of income along with an increase in ownership of the shareholders. Therefore, bonus shares create a value proposition for the existing shareholders of the company.
The issuance of bonus shares increases the number of outstanding shares of the company. These bonuses are paid in proportion to the existing shareholding pattern to the shareholders. That means shareholders having more shares will get more bonus shares. For example, if bonus shares are issued in a proportion of 1:10, a shareholder having 100 shares will get 10 new bonus shares.
The issue of bonus shares increases the paid-up capital but reduces the earnings, reserves, and surplus of the company. The total net worth of a company is, however, not altered by the issuance of bonus shares. That means that the paid-up capital and reserves and surplus remain the same for the company that issues the bonus shares.
According to some analysts, bonus share issuance is a recapitalization of the reserves and surpluses of a company. By paying additional shares, the value of shares goes down. So, the net worth of a shareholder having bonus shares remains the same. However, when the value of the share goes up in the market, the shareholders get an additional premium in the value of the shares. Otherwise, there is no net effect of the issuance of bonus shares.
Bonus shares represent the transfer of money from reserves and surplus to paid-up capital. This is only an accounting transfer that results in a shift of capital to another account. Bonus shares do not carry extra value. It is just a measure to offer the shareholders more ownership.
Conclusion
Many companies prefer offering bonus shares to their shareholders by thinking from the point of view of the shareholders. As shareholders want to increase both their income and ownership, bonus shares are usually offered with some dividends. However, the issue of bonus shares does not change the overall value of the share or the company.
If the value of a share does not rise in the market, additional shares cannot make up for the loss of value of the company. However, an increase in share price may increase the income of the existing shareholders who get the bonus shares.
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