What it means
The mechanics are an accounting transfer rather than a transaction. The company moves an amount out of retained earnings or a share premium account and into issued share capital, then hands out the new shares on a stated ratio such as one new share for every four held.
Companies do this for practical reasons. A share price that has climbed to an awkward level can deter smaller investors, and increasing the number of shares brings the price down to a friendlier range while improving how easily the shares trade.
The market value adjusts automatically. If the total market capitalisation was unchanged before and after, the price per share must fall by the same proportion that the share count rose, which is why a bonus issue is sometimes described as slicing the same cake into more pieces.
There is a signalling effect, though. Boards usually make a bonus issue when they are confident about future earnings, since they are permanently converting distributable reserves into capital that cannot easily be paid out later.
Two close relatives cause confusion. A scrip dividend gives shareholders a choice between cash and shares, and a share split changes the nominal value of each share without touching reserves at all, whereas a bonus issue is neither optional nor reserve-neutral.
There are limits on which reserves can be used, and company law in most jurisdictions specifies them, so the finance team checks the position with legal advisers before a board announcement. Reporting also has to be adjusted, because every historical earnings per share figure must be restated as though the extra shares had always existed.
In practice
Real-world examples.
Example
A brewery whose shares have risen from $12 to $95 over eight years makes a one-for-three bonus issue to bring the price closer to $71. Retail trading volumes improve noticeably in the following quarter, which was the board's stated aim.
Example
An engineering group with a large share premium account and limited distributable profits uses a bonus issue to reward shareholders in a year when cash is committed to a new factory. Investors receive more shares without the company spending a cent.
Example
A finance analyst updating a five-year earnings per share chart restates every prior year after a one-for-two bonus issue. Without the restatement the chart would show a sudden fall in earnings per share that had nothing to do with trading performance.
Think of it
“Bonus issue is free shares from the company-existing shareholders get more stock.
Formula
Calculation
New shares issued = existing shares x bonus ratio
Theoretical share price after issue = market capitalisation before / total shares after
A listed components maker has 8,000,000 shares trading at $20.00, giving a market capitalisation of 8,000,000 x $20.00 = $160,000,000. It announces a one-for-four bonus issue, so it creates 8,000,000 / 4 = 2,000,000 new shares and the total becomes 8,000,000 + 2,000,000 = 10,000,000 shares.
Since no cash entered or left the business, the theoretical price becomes $160,000,000 / 10,000,000 = $16.00 per share. An investor who held 400 shares worth 400 x $20.00 = $8,000 now holds 500 shares worth 500 x $16.00 = $8,000, exactly as before.
Annual earnings of $20,000,000 mean earnings per share falls from $20,000,000 / 8,000,000 = $2.50 to $20,000,000 / 10,000,000 = $2.00. The price to earnings ratio is unchanged at $20.00 / $2.50 = 8.0 before and $16.00 / $2.00 = 8.0 after.Case study
Seen in the real world.
This is an illustrative and entirely fictional example. Kestrel Precision Holdings, an invented instrument maker, saw its share price reach $240 after a strong decade, a level at which its broker reported that private investors were buying in odd, uneven parcels because a round lot had become expensive.
The fictional board approved a four-for-one bonus issue, taking the share count from 5,000,000 to 25,000,000 and the theoretical price from $240 to $48. Nothing about the business changed, and the market capitalisation stayed at $1,200,000,000 on the day.
Kestrel's imagined investor relations team then spent a fortnight fielding calls from shareholders who believed the company had lost 80% of its value. The lesson its finance director drew was that a bonus issue needs a plain-English explanation issued alongside the announcement, not just a technical circular.
Watch out
Common mistakes.
- Believing a bonus issue makes shareholders richer, when the value of each holding is identical immediately afterwards.
- Reading the drop in share price on the effective date as a market fall rather than a mechanical adjustment.
- Comparing earnings per share before and after without restating prior periods, which makes performance look artificially worse.
Questions
People also ask.
Does a bonus issue raise money for the company?
No, it moves reserves into share capital and brings in no new cash at all.
How is it different from a share split?
A split changes the nominal value per share with no reserve transfer, while a bonus issue capitalises reserves into new shares.
Why would a board choose this over a cash dividend?
Usually to conserve cash, to widen the shareholder base by lowering the share price, or to signal confidence in future earnings.
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