What is the objective behind a bonus issue?

 

A bonus issue,  also known as a scrip issue or capitalization issue, is a corporate action in which a company distributes additional shares to its existing shareholders at no extra cost, based on the number of shares that the shareholders already own. This practice is often employed by companies as a method of rewarding shareholders, enhancing market liquidity, signaling positive company performance, and achieving several other strategic financial objectives. Below, we delve into the objectives behind a bonus issue in a comprehensive manner.

 

1. Enhancing liquidity and marketability

 

   A key objective of issuing bonus shares is to improve the liquidity and marketability of the company’s shares. When a company issues bonus shares, the number of shares in circulation increases, which usually leads to a reduction in the share price, making it more affordable and appealing to a broader range of investors. This increase in affordability can lead to higher trading volumes, as more investors are able to buy and sell the shares. Higher liquidity typically results in tighter bid-ask spreads and more efficient price discovery, which can enhance the overall attractiveness of the company’s stock.

 

2. Signaling financial health and positive performance

 

   Bonus issues are often interpreted as a signal of a company's strong financial health and positive future prospects. By distributing additional shares, the company indicates that it has ample retained earnings and reserves, which suggests robust profitability and effective management. This positive signal can boost investor confidence and potentially lead to a higher market valuation of the company’s shares over time. The market generally perceives bonus issues as a sign that the company is performing well, thereby enhancing the company's reputation and market standing.

 

3. Adjusting share price to an optimal trading range

 

    High share prices can sometimes act as a barrier for potential investors, particularly small or retail investors who may find the shares too expensive. By issuing bonus shares, a company can effectively reduce the share price to a more manageable level, making it accessible to a wider range of investors. This adjustment can be particularly beneficial in markets with minimum trading lot requirements, where high share prices could limit participation. A lower, more attractive share price can encourage greater participation in the stock market, potentially increasing the shareholder base.

 

4. Rewarding shareholders

 

    A bonus issue is a way for companies to reward their shareholders by providing them with additional shares. This increase in the number of shares held by shareholders does not dilute their ownership percentage or reduce the value of their investment, as the overall market capitalization of the company remains unchanged. Shareholders receive a tangible benefit from the company's retained earnings, which can improve shareholder satisfaction and loyalty. Although it does not provide immediate cash returns, the additional shares have the potential to increase in value, especially if the company continues to perform well.

 

5. Capital restructuring and financial management

 

    Companies may use bonus issues as a tool for capital restructuring. By converting retained earnings or reserves into share capital, a company can present a more balanced capital structure. This can be particularly useful for companies aiming to maintain or achieve a specific debt-to-equity ratio, improve their balance sheet, or comply with regulatory requirements regarding capital reserves. A healthier capital structure can enhance the company’s financial stability and attractiveness to investors.

 

6. Improving market perception and visibility

 

    Issuing bonus shares can positively influence a company’s market perception. It can be seen as a proactive measure by the management to enhance the company's visibility in the market and attract more investors. A well-timed bonus issue can generate positive media coverage and investor interest, leading to increased demand for the company’s shares. This improved market perception can contribute to a higher stock price and better overall valuation.

 

7. Increasing shareholder wealth over the long term

 

   While a bonus issue does not directly increase shareholder wealth, it has the potential to do so indirectly. If the market reacts positively to the bonus issue and the share price appreciates over time, shareholders can benefit from an increase in the overall value of their holdings. Additionally, with more shares, shareholders may receive higher total dividend payouts if the company declares dividends in the future. The issuance of bonus shares can thus be part of a long-term strategy to enhance shareholder value.

 

8. Encouraging long-term investment

 

   By issuing bonus shares,  companies can encourage shareholders to hold onto their investments for a longer period. The additional shares can be seen as a sign of the company's confidence in its future growth and profitability, which may persuade investors to remain committed. This can lead to a more stable shareholder base and reduce short-term trading and speculation. Long-term investors are often seen as more beneficial to the company, as they are more likely to support strategic decisions and provide stable capital.

 

9. Tax efficiency for shareholders

 

    In certain jurisdictions,  a bonus issue might be more tax-efficient for shareholders compared to cash dividends. While cash dividends are often subject to immediate taxation, the receipt of bonus shares does not typically incur immediate tax liabilities. Shareholders may defer capital gains tax until they decide to sell the shares, potentially benefiting from lower tax rates or exemptions available at that time. This tax efficiency can be an attractive feature for investors, encouraging them to hold onto the shares for longer periods.

 

10. Aligning with growth and expansion strategies

 

   A bonus issue can align with the company’s growth and expansion strategies by providing a mechanism to reinvest profits back into the company. Instead of distributing cash dividends, which can deplete the company’s reserves, issuing bonus shares allows the company to use retained earnings to support expansion plans, research and development, or other strategic initiatives. This reflects the company’s commitment to using its profits to fuel further growth and innovation, which can be crucial for long-term success.

 

11. Psychological impact on investors

 

   The psychological impact of a bonus issue on investors should not be underestimated. Receiving additional shares can create a sense of abundance and satisfaction among shareholders, even if their proportional ownership and the total value of their holdings remain unchanged. This psychological boost can enhance shareholder morale and loyalty, fostering a positive relationship between the company and its investors.

 

Conclusion

 

    A bonus issue serves multiple strategic objectives, from enhancing liquidity and signaling positive performance to rewarding shareholders and encouraging long-term investment. It is a versatile tool that companies can use to manage their capital structure, improve market perception, and align with their broader growth strategies. While it does not immediately increase shareholder wealth, its potential indirect benefits can make it an attractive corporate action for both the company and its investors. By carefully considering the timing and rationale behind a bonus issue, companies can leverage this mechanism to support their financial and strategic goals, ultimately contributing to sustained growth and success.