Bonus Shares: Merits and Demerits¶
Bonus shares, also known as scrip dividends or capitalization issues, are additional shares issued by a company to its existing shareholders without any cash consideration. These shares are given to shareholders in proportion to their existing holdings. The issuance of bonus shares is a common corporate action that has both advantages (merits) and disadvantages (demerits).
Merits of Bonus Shares:¶
1. Conservation of Cash:¶
Preservation of Cash Reserves: By issuing bonus shares instead of cash dividends, the company conserves its cash reserves. This can be particularly beneficial during periods of financial uncertainty or when the company needs cash for investments, debt reduction, or other strategic initiatives.
2. Increased Liquidity:¶
Improved Liquidity: Bonus shares increase the number of shares held by each shareholder without changing the overall market capitalization of the company. This can enhance the liquidity of the company's stock in the market, making it more attractive to investors.
3. Enhanced Attractiveness:¶
Investor Attraction: Bonus shares can make a company's shares more affordable to a wider range of investors. This can attract new shareholders and potentially increase demand for the company's stock.
4. Positive Signal:¶
Positive Signal: Issuing bonus shares is often viewed as a signal of confidence by the company's management in its future prospects. It can boost investor confidence and enhance the company's image.
5. Retention of Control:¶
Retained Ownership: Existing shareholders maintain their proportional ownership in the company even after the issuance of bonus shares. This is particularly important for controlling shareholders who want to maintain their influence.
Demerits of Bonus Shares:¶
1. Dilution of Earnings:¶
Earnings Dilution: Bonus shares do not result in any increase in the company's earnings. Instead, the same earnings are spread over a larger number of shares, which can dilute the earnings per share (EPS) and potentially reduce the attractiveness of the company's stock to investors.
2. Limited Impact on Shareholder Wealth:¶
No Wealth Creation: While bonus shares increase the number of shares held by shareholders, they do not result in an immediate increase in the wealth or value of the shareholder's investment. Shareholders may need to sell the additional shares to realize any financial benefit.
3. Administrative Costs:¶
Administrative Expenses: Issuing bonus shares involves administrative costs, including legal and regulatory compliance, printing and distribution of new share certificates, and communication with shareholders.
4. Market Reaction:¶
Market Reaction: The market's reaction to bonus share issuance can be mixed. It may not always lead to a significant increase in the company's stock price, especially if investors view it as a neutral event.
5. Tax Implications:¶
Taxation: In some jurisdictions, bonus shares may be subject to taxation when they are issued. Shareholders could incur tax liabilities even though they have not received any cash.
In summary, bonus shares offer advantages such as preserving cash, improving liquidity, and signaling confidence, but they also come with drawbacks like earnings dilution and administrative costs. Companies need to carefully consider their financial situation, investor preferences, and strategic objectives before deciding to issue bonus shares.