Additional Share Allotment Explained: Functioning and Process
Going the Extra Mile: Free Shares Await!
Ever wondered what happens when a company rewards its loyal stockholders with some extra goodies? That's where bonus issues come into play! Here's a lowdown on this exciting pocket-filler.
What Is a Bonus Issue?
Imagine receiving free cake slices at your favorite bakery because you're a regular customer. Bonus issues are basically the same, but with shares instead of sweets! Companies offer these free, additional stocks to existing shareholders as a token of appreciation and to attract more investment.
For example, a company might bless you with one bonus share for every five shares you already own. Easy peasy!
Key Takeaways
- Bonus shares upsize a company's share capital without making a dent in its market capitalization.
- Companies dip into their earnings or share reserves to fund bonus issues.
- Bonus issues don't dilute shareholders' equity because the ratio stays the same, keeping each shareholder's sway the same.
- Companies love bonus issues because they help make their stock more appealing for everyday investors, provide an alternative to a cash dividend, and showcase their financial well-being.
- However, there's a downside; the opportunity cost of using earnings for other potential moneymakers. More on that later!
Grasping Bonus Issues
Bonus issues don't change a company's market capitalization as they increase its outstanding shares but not the market value. Companies typically fund bonus issues via profits or existing share reserves. The issuance of bonus shares is tax-free; however, shareholders might have to cough up a capital gains tax if they flip their shares for a profit.
A company disburses bonus issues based on each shareholder's weight. Bonus shares won't dilute shareholders' equity as they're handed out in a consistent ratio, preserving each shareholder's relative equity.
Example Time!A three-for-one bonus issue means every shareholder gets three shares for every one they held before the issue. So, if you owned 1,000 shares, you'd now have 3,000 bonus shares (1,000 x 3 ÷ 1 = 3,000).
The Fine Print
When a company dishes out bonus shares, its share price automatically adjusts to the new number of shares.
Why Do Companies Opt for Bonus Shares?
Companies issue bonus shares for a variety of key reasons:
- They lure more retail investors by making shares more affordable and easier to trade.
- Bonus issues offer an alternative to cash dividends to reward shareholders.
- Companies in tip-top financial shape might issue bonus shares to demonstrate their ability to continuously generate value for shareholders.
Let's delve deeper into these reasons!
Perks of Bonus Shares
They're a Magnet for Retail Investors: Bonus shares improve a company's liquidity and reduce its share price, making it simpler for everyday investors to step aboard and snag some shares. Lower-priced shares allow investors to own more units, while greater liquidity keeps trading costs down.
Alternative to Dividends: Bonus issues are a great substitute for cash dividends, especially for small companies that can't manage regular dividends but still wish to attract investors. Bonus issues can endorse investor trust when profits aren’t consistent.
Sign of Financial Health: A company issuing bonus shares broadcasts its robust financial standing, engaging current shareholders and attracting new ones.
Tax Benefits: Bonus shares don't get taxed when issued, unlike cash dividends. Nonqualified dividends get smacked with a tax rate of 10% to 37%. Instead, investors have to pay capital gains tax when they sell bonus shares for a profit.
Downsides of Issuing Bonus Shares
Opportunity Cost: Companies could use the funds set aside for a bonus issue on deals that might create a higher return for shareholders.
Possible Reduction in Dividends: Issuing bonus shares doesn't bring in any cash for a company, which could lead to decreased future dividends, disappointing shareholders. Some shareholders may also believe that the company might prioritize bonus shares over cash dividends in the future.
No Immediate Financial Gain: Unlike a cash dividend, shareholders don't reap immediate monetary benefits because the company's stock price adjusts proportionally to the number of bonus shares issued.
So, there you have it! Bonus issues are a strategic move to reward shareholders, attract new investors, and signify a company's financial strength. But, as always, there are potential downsides to consider.
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Footnotes:
[1] Investopedia. (n.d.). Dilution Definition and Examples. Investopedia. https://www.investopedia.com/terms/d/dilution.asp
[2] Securities and Exchange Commission. (n.d.). Understanding Your 1099-DIV. IRS. https://www.sec.gov/investor/pubs/intro1099div.htm
[3] Securities and Exchange Commission. (n.d.). The Basics of Corporate Governance: Role of the Board of Directors. IRS. https://www.sec.gov/investor/pubs/intro-corpgov.htm
[4] The Balance. (2021, June 15). What Is Earnings Per Share (EPS)? The Balance. https://www.thebalance.com/eps-earnings-per-share-2299555
[5] Algorithmia. (2021, September 2). Bonus Share Issue Explained. Algorithmia. https://news.algorithmia.com/bonus-share-issue-explained/
Additional Insights:
- Bonus issues can be volatile. Share prices may fluctuate in the short term, but they generally return to their normal levels in the long term.
- Sometimes, companies issue bonus shares to prevent a takeover. This is known as a poison pill strategy.
- Bonus issues can lead to a dilution of earnings per share (EPS). However, this doesn't affect shareholders' equity as the bonus shares are issued proportionally.
- Companies might issue bonus shares to keep the share price artificially high, making it less vulnerable to takeovers. This is known as a staggered share structure.
- Bonus share issues are subject to regulatory approval and must adhere to specific guidelines set by securities commissions.
- Bonus shares can be detrimental if the market values the company based on its earnings per share (EPS). This is because bonus shares increase the number of outstanding shares, thereby decreasing EPS, diluting the company's value from an earnings standpoint.
- In the realm of financial markets, the offering of bonus shares to existing stockholders can be likened to receiving extra free tokens in a Defi market.
- These bonus tokens, provided as a gesture of gratitude, can potentially attract more trading and investment, much like a company aiming to advertise its financial health and growth.
- The distribution of these bonus tokens doesn't increase the market cap, as it raises the total supply without impacting the value per token, similar to a company's share capital upsizing without affecting its market capitalization.
- Companies may fund these bonus token distributions through their earnings or reserves, mirroring the way companies use their profits or share reserves to issue bonus shares.
- The ratio of tokens remains consistent when bonus tokens are distributed, ensuring no disadvantages to the individual shareholders, just as the bonus issue of stocks doesn't dilute shareholders' equity.
- Issuing bonus tokens can have advantages, such as enhancing liquidity within the token market, offering an alternative finance option to Initial Coin Offerings (ICOs), and serving as a way to showcase a Defi project's financial performance and potential.
- However, there are potential drawbacks to consider, such as the opportunity cost of using funds to issue bonus tokens instead of investing in other promising projects or businesses.
