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What are bonus shares , its advantages & disadvantages ?

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Bonus shares are among popular corporate actions along with dividends. Companies which can not pay a dividend in the form of cash because of liquid funds crisis in spite of earning a good profit as they want to retain some good amount of profit in their reserves issues additional shares to its existing shareholders which are known as bonus shares. Characteristics of these shares are similar to those which shareholders already own with one difference, earlier shares were issued against the receipt of consideration in cash and bonus shares are issued for free of cost. Because of this reason, it is termed as a bonus. Once they are issued by the company like other shares they are successfully reflected in Demat account of investors.
Following are some of the advantages of bonus shares:
From company's point of view
  • Issue of bonus shares facilitates a company to conserve cash which can be further reinvested for carrying out different operational and functional activities.
  • At times when a company is not in a position to pay dividends in the form of cash then the only means to satisfy shareholder's desire for dividend is giving them some extra shares in the form of a bonus.
  • Helps in building a better market image and attract more number of small investors.
From investors point of view
  • Investors get tax benefits as no tax is levied on additional bonus shares issued to them.
  • Long term investors are benefited to large extent with these shares as they are willing to expand their investment in that company and believe in long term story of the company.
  • In future when the company will pay a dividend in the form of cash, investors will receive more as they will be holding more number of shares.
Disadvantages of bonus shares
From company's point of view
  • With this additional issue of shares, the company does not receive any cash which reduces the company's ability to raise its capital.
  • Issue of bonus increases the number of outstanding shares which will decrease future EPS (Earning Per Share).
From investors point of view
  • Not all investors are happy with the bonus shares. As they may be interested in cash to fulfill their other objectives for which they have made this investment.
  • It does not give any extra wealth to shareholders as share price drops to some proportionate amount to maintain the market capital of the company same as before.
These are some of the advantages and disadvantages of bonus shares. They can be issued after twelve months from the issue of shares for consideration and only out of reserves which are created from profit realized in cash that is a company must have a significant amount of undistributed profit. Also this proposal made by the board of directors is first approved by existing shareholders in a general meeting.
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