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Bonus shares are the shares issued by a company free of costs by capitalisation of its profits and reserves. The issue of bonus shares results in increase in number of shares and hence increases the paid up capital of company without involving any monetary transaction. Such shares are issued to all existing equity shareholders in proportion of their holding of share capital of company. Since, the number of shares increases as a result of bonus shares, the book value and earnings per share of company will decrease.
The mechanism of bonus share is simple. The firm first issues additional shares by passing a resolution and then distribute these shares among existing shareholder in proportion to their holding. The bonus shares do not alter the proportional ownership of firm as far as existing shareholders are concerned. As the bonus issue does not effect the cash flows or the operational efficiencies of the firm, there should not be any change in total value of firm. The market price per share would decrease but shareholder are no worse off after the bonus, notwithstanding such decrease because they receive compensatory increase in number of shares held.
Reasons for issue of Bonus Shares
Companies have a common tendency to issue bonus shares to their shareholders. Many companies have issued bonus shares once a while, whereas some other companies have issued bonus shares on regular basis. Companies such as Bajaj Auto Ltd., Hindustan Level Ltd. have issued bonus shares on regular basis. Companies prefer issue of bonus shares as against payment of cash dividend for several reasons as follows:
1. When a company issues bonus shares, it utilises a part of profit of company and also rewards the shareholders but without affecting liquidity of company.
2. Since, bonus shares is capital receipt, it is not taxable in hands of issuing company as well as shareholders.
3. Issue of bonus shares increases the goodwill of company in capital market and build confidence among investors and helps raising additional funds in future.
4. Bonus issue helps a company to streamline its capital structure and bring its paid-up capital in line with capital employed in business.
5. It makes available capital to carry on a larger and more profitable business.
6. It enables a company to make use of its profits on a permanent basis and increases creditworthiness of the company.
7.The balance sheet of the company will reveal a more realistic picture of the capital structure and capacity of the company.
8.The investors can easily sell these shares and get immediate cash, if they so desire.
9.The bonus shares are a permanent source of income to the investors.