INTRODUCTION

The Oxford English Dictionary gives the meaning of bonus shares as; “an extra dividend paid to share holders in a joint stock company from surplus profits”.

In legal context, a bonus share is not a dividend.

The guidelines issued by the ministry of Finance prohibit declaration of bonus shares in lieu of dividends. Bonus shares may be issued in addition to dividends. In bonus issue, shares are issued to existing shareholders as a gift i.e. without charging any payment.

Kausik Adhikari - 1001

What are Bonus Shares?

Kausik Adhikari - 1001

What does the Ratio of Bonus Shares mean?

Bonus shares in India are issued in a definite proportion to the existing holding.  (E.g. Ratios against the number of shares holding by the shareholder)

Example – A 1:2 bonus would mean that you will get one additional share (free) for every two shares you hold in the company. If you hold 100 shares of a company, a Bonus share of 1:2 will get 50 Bonus shares FREE. So your total number of shares in that company will be 150 instead of 100, without any additional cost.

Kausik Adhikari - 1001

Does it impact Stock Price?

Bonus Shares issue adds to the total number of shares in the market. If a company had 10 lakh shares. Now, with a bonus issue of 2:1, there will be 20 lakh new shares issues. Now, there will be 30 lakh shares.The earnings of the company will have to be divided by that new number of shares.

Earnings Per Share (EPS) = Net Profit / Number of Shares Outstanding

As the profits remain the same and the number of shares increases, the value of Earnings Per Share (EPS) will go down. In fact, the stock price should also go down proportionately to the number of new shares. But sometimes, in reality, the share prices may not go down, which gives more advantage to the share holder.

Kausik Adhikari - 1001

Process of Bonus Issue

Bonus shares can be issued by a company only if the Articles of Association of the company authorize a bonus issue.

Where there is no provision in this regard in the articles, then Articles of Association must be amended by passing a special resolution at the general meeting of the company.

It must be sanctioned by shareholders in the general meeting on recommendations of the Board of Directors of the company.

It must be ensured that the issue of bonus shares do not lead to total share capital in excess of the authorized share capital. Otherwise, the authorized capital must be increased by amending the capital clause of the Memorandum of Association

Emamul Mallik - 1050

Bonus shares may be issued at par or at a premium. Before the issue of bonus shares the existing shares must be fully paid. When bonus shares are issued, the company’s Balance-Sheet must show how much of the share capital consists of bonus shares.

If the company has availed of any loan from financial institutions, prior permission for the issue of bonus shares has to be obtained from these lending institutions.

If the company is listed on the stock exchange, the stock exchange must be informed of the decision of the board to issue bonus shares immediately after the board meeting.

Where the bonus shares are to be issued to the non-resident members, prior consent of the Reserve Bank should be obtained.

Emamul Mallik - 1050

Sources of Bonus Issue:

In case of Fully paid-up Equity shares bonus shares can be issued from the following:

Profit and Loss Account General Reserve Capital Reserve Sinking Fund for Redemption of Debentures (after

redemption) Capital Redemption Reserve Securities Premium

Emamul Mallik - 1050

In case of Partly paid-up Equity shares bonus shares can be issued from the following:

Profit and Loss Account General Reserve Capital Reserve Sinking Fund for Redemption of Debentures (after

redemption)

Emamul Mallik - 1050

The result from the issue of bonus shares is the increase in the number of shares outstanding.

In the equity portion of the firm, a bonus issue reduces the retained earnings and correspondingly increases paid-up equity share capital.

Issue of bonus shares is a conversion of reserves into share capital.

Amit Kathe - 1042

Amit Kathe - 1042

Reasons for issuing Bonus Shares

The bonus issue tends to bring the market price per share within a more reasonable range.

It increases the number of outstanding shares. This promotes more active trading.

The nominal rate of dividend tends to decline. This may dispel the impression of profiteering.

Share capital base increases and the company may achieve a more spectacular size in the eyes of the investing company.

Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened and they can reasonably look for an increase in total dividend.

It improves the prospects of raising additional funds.

Amit Kathe - 1042

Regulation of Bonus Issues

Important regulatory provisions governing issue of bonus shares are:

1. The bonus issue is made out of free reserves built out of the profits or share premium collected in cash only.

2. The residual reserves after the proposed capitalization shall be at least 40% of the increased paid up capital.

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Advantages of bonus shares issue to the company

Conservation of Cash Keeps the EPS at a reasonable level Increases the marketability of company's shares Enhances prestige of the company It helps in financing its projects Retention of managerial control

Advantages to the shareholder Tax benefits Indicates higher future profits Increase in future dividend High psychological value

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Limitations of Bonus Issues Disadvantages for the company:

The increased capitalization can be justified only if there is increase in the earning capacity of the company

It is really a challenging task for the company to retain the existing rate of dividend per share

Issue of bonus shares prevents new investors from becoming the shareholders of the company (no doubt they can buy the shares in the secondary market).

Naresh Deulkar - 1051

Naresh Deulkar - 1051

Stock SplitsIn a stock split the face value per share is reduced and the

number of shares is increased proportionately.

Naresh Deulkar - 1051

RELIANCE POWER BONUS ISSUE

Reliance Power Ltd (RPL), part of the Reliance Anil Dhirubhai Ambani Group (ADAG), announced it would give 3 bonus shares for every 5 held in an effort to reduce losses by shareholders after the poor performance of the stock after its listing on February 11,2008.

After the Reliance Power board meeting , Reliance Power Chairman Anil Ambani said that the bonus issue would not apply to promoters

Anil Ambani gave up Rs 5,000 crore ($1.2 billion) of his personal wealth to enable Reliance Power shareholders to make up for their losses caused by the dismal listing of this high-profile stock.

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To ensure that retail and institutional shareholders of Reliance Power and shareholders of Reliance Energy Ltd do not suffer losses, Mr.Ambani has decided to dilute his holding in Reliance Power so that others, including 6 million retail shareholders, can be compensated

The promoter group includes Reliance Energy (with a 45 per cent stake) and the Anil Dhirubhai Ambani Group (another 45 per cent). Retail and institutional shareholders hold the remaining 10 per cent.

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With this, the cost of Reliance Power shares will come down to Rs 269 each for retail investors and Rs 281 each for institutional investors. This translates into a 40 per cent discount from the IPO price of Rs 430 for retail investors and 37 per cent from the IPO price of Rs 450 for institutional investors.

The bonus issue increased the holding of retail and institutional investors in Reliance Power from the current 10 per cent to 15 per cent, while the holdings of Anil Ambani and the ADA Group came down from 45 per cent to 40 per cent. Reliance Energy, the parent company, retains its holding at 45 per cent.

Anil Anayath - 1005

So what was the effective price of the retail investors’ shares?

Retail investors were offered shares at 430. Someone receiving 15 shares would have paid 15*430 = Rs. 6450 in total. Now, he will receive 9 more additional shares as bonus, without any extra cost.

Therefore, at the same price of Rs.6450, his share holding will increase to 24 shares. Therefore, his effective price will become 6450/24 = Rs. 268.75 only, for each share. Hence, the investors were benefited because the market price of Reliance Power shares was trading above Rs. 400

Anil Anayath - 1005

What about QIB?

The other investors were allotted the shares of Reliance Power at a Price of Rs. 450. Hence, for 15 shares they paid 450 * 15 = 6750. After Bonus Issue of Reliance Power, the no. of shares will increase to 24. Hence, their effective price will become 281.25 Rs per share. Again beneficial, as the stock price of Reliance Power was around Rs.400

All in all, it was a good move by Reliance Power Promoters. Anil Ambani himself had divested his holdings in Reliance Energy and Reliance Power to absorb the losses. It should help in marinating the Reliance brand, as a reliable name in India and the world.

Anil Anayath - 1005

SUMMARY

When the additional shares are allotted to the existing shareholders without receiving any additional payment from them, it is known as issue of bonus shares.

Bonus shares are allotted by capitalizing the reserves and surplus.

Issue of bonus shares results in the conversion of the company's profits into share capital. Therefore it is termed as capitalization of company's profits.

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Since such shares are issued to the equity shareholders in proportion to their holdings of equity share capital of the company, a shareholder continues to retain his / her proportionate ownership of the company.

Issue of bonus shares does not affect the total capital structure of the company. It is simply a capitalization of that portion of shareholders' equity which is represented by reserves and surpluses.

It also does not affect the total earnings of the shareholders.

Issue of Bonus Shares is more or less a financial gimmick without any real impact on the wealth of the shareholders. Still firms issue bonus shares and shareholders look forward to issue of bonus shares.

Anil Anayath - 1005

KAUSIK ADHIKARI – 1001

ANIL ANAYATH – 1005

NARESH DEULKAR – 1051

EMAMUL MALLIK – 1050

AMIT KATHE – 1042