What Are Bonus Shares and How Do They Work?

What are Bonus Shares? 

The bonus shares meaning states that they are the additional set of shares allotted by the company to the existing shareholders as a 'bonus.' These additional shares are allotted because the company can't pay dividends to shareholders despite making profits. However, bonus shares can only apply when the company has a massive free reserve and has booked hefty profits. 

Furthermore, these reserves or profits cannot be used for other purposes than to distribute dividends. The bonus shares are distributed according to the shareholder's proportionate share in the company. 

For example, if a company announces a one-for-one bonus share, the shareholder will hold double its current holding. Let's assume shareholder A had 200 shares in company XYZ. After announcing one on one bonus shares, shareholder A will hold 400 shares in company XYZ. 
 

How Do Bonus Shares Work?

Bonus shares are extra shares that are issued to present owners at no additional cost, based on the number of shares they currently own. Most people mistake stock splits for bonus concerns. This is due to the fact that, similar to stock splits, bonus issues can result in a rise in the company's share count.

In contrast to a stock split, where the face value of each share is decreased, a bonus issue offers existing owners more shares at no cost in proportion to the shares they now possess in the company. 

Therefore, bonus shares raise the company's share capital while a stock split keeps it constant. However, in both scenarios, the number of shares rises and the share price falls accordingly.

Who is eligible for bonus shares? 

The shareholders who hold the company's shares before the record date and ex-date qualify to receive the bonus share. In India, companies follow a system wherein the record date falls two days after the ex-date. To earn bonus shares, shareholders must hold shares before the ex-date. If someone bought shares on the ex-date, they wouldn't qualify for earning bonus shares. 

The bonus shares are allotted after they get their new ISIN. The process usually takes 15 days. 
 

Types of Bonus Shares 

The companies can choose to announce bonus shares or not. They can pick from 

● Fully paid bonus shares

The bonus shares come from the capital reserve, redemption reserve, profit and loss account, or security premium account. These shares are not circulated with an increased proportion. Instead, the shareholders get the exact number of shares they held before the ex-date. 

● Partially paid bonus shares 

The partially paid bonus shares apply to the partially paid shares. These are the shares the shareholders partially paid at issuance. The rest of the amount is due when the company makes the call. 

When the company announces a partially paid bonus, the remaining amount of shares gets fulfilled. The partially paid shares become fully paid shares. These bonuses can be issued from the capital reserve. The company can't use the capital redemption reserve and security premium account to issue partially paid bonus shares.
 

Why do companies issue bonus shares?

The question now becomes, "Why do companies issue bonus shares if the stock price decreases in the same ratio as the bonus issue?"

1. To promote involvement in retail: 
A company's share price that is too high will discourage some investors from purchasing it. Typically, novice investors are reluctant to purchase stocks that have a greater price per unit. Bonus shares are issued in greater quantity and at a lower price per share, which makes them more accessible to regular investors. Additionally, greater stock availability promotes liquidity, or the ease and speed with which a stock can be bought and traded on the market.

2. To demonstrate strong financial standing, the corporation awards bonus shares based on earnings or in situations when it has significant cash reserves that are not urgently needed. When a business issues bonus shares from reserves or profit, it shows that it is profitable and strong enough to issue additional equity shares.  

Guidelines to Be Followed by a Company Before Issuing Bonus Shares

Before a company embarks on issuing bonus shares, it must comply with regulatory and accounting rules. Here are some key guidelines:

• The bonus shares must be issued out of free reserves, securities premium account, or capital redemption reserve, but not out of revaluation reserves.
• No bonus issue can be made if the company has unpaid debentures or statutory dues, or partially paid-up shares pending.
• The company’s Articles of Association must authorise the issue of fully paid-up bonus shares and the approval must be passed by the board/shareholders as per rules.
• Usually the entire process has to be completed within the timeframe prescribed (for instance, the issue should be effected within a certain period after approval) and you cannot retract the bonus once declared.

What Is the Record Date?

The record date is the cut-off day that a company fixes to determine which shareholders will be eligible for the upcoming bonus share issue. In simple terms: if you’re holding the stock in your demat account on that date, you qualify for the bonus. For example, when you see a company announce a bonus ratio (say 1:2) and mention a record date of 30 June, only the shareholders on the register as of that day will receive the extra shares.

It’s important because share ownership changes frequently - so the record date ensures the company locks in the list of eligible shareholders.

What Is the Ex-Date?

The ex-date (often called the “ex-bonus date” when dealing with bonus shares) is the first trading day after which new buyers of the stock are not eligible for the bonus issue. Usually, this falls one business day before the record date, given the trade settlement cycle.

Here’s the practical rule: if you want to make sure you get the bonus, buy the shares before the ex-date (or on the ex-date if the settlement allows), and hold through the record date. Miss that window and you’re out of luck - even if you buy the share the next day.

Advantages of Bonus Shares 

Bonus shares benefit both the company and shareholders. Here's how: 

Company

●    Bonus shares help the company sail out of the situation of sharing cash dividends with the shareholders. 
●    Shareholders gain trust in the company after receiving bonus shares. 
●    The company increases its shareholding and spikes market value with bonus shares. 
●    Bonus shares signify that a company has had a good financial year. 

Investors

●    Investors earning bonus shares fall out of taxation.
●    It is a promising option for long-term holders. 
●    Investors have increased their holdings in the company without spending anything. 

Disadvantages of Bonus Shares

There are some disadvantages to bonus shares too. Here are a few: 

Company

●    Shares help in raising money. However, bonus shares raise no money and defy the concept of shares. 
●    If a company opts to issue bonus shares over dividends, it increases the burden on the company in the long run. 
●    Shareholders who invest to earn dividends might step back from further investment. 

Investors

●    There is not much of a disadvantage for an investor. However, if the investor was eyeing a dividend, bonus shares can be disappointing for them. In the long run, bonus shares could be a better deal. 
 

Conclusion

To summarise that, what is bonus share, the bonus shares meaning involves distributing extra shares to shareholders, usually from the company's accumulated earnings or reserves. To define bonus shares, they are essentially free shares issued to shareholders, which increases the total number of shares held and reflects the company's intent to reward its investors.