When companies issue bonus shares and right shares, they offer unique opportunities to existing shareholders. But how do these processes work, and what do they mean for investors? Understanding the differences between a right issue of shares and bonus shares can help investors make informed decisions about their portfolios.
Bonus Shares and Right Shares: How Do They Work?
Bonus shares and right shares are mechanisms by which a company can issue additional shares to existing shareholders, but they serve different purposes and have distinct characteristics. Here’s what they are and how they work:
Bonus Shares - Bonus shares are additional shares given to existing shareholders without any cost, issued out of the company's retained earnings or reserves. These shares serve to reward shareholders and increase the stock's liquidity while allowing the company to reinvest its retained earnings without altering the total equity.
For shareholders, the issuance of bonus shares increases their share count but does not immediately enhance their overall investment value as the market adjusts the share price proportionally. For example, with a 1:1 bonus issue, the number of shares a shareholder owns will double, but the share price will typically halve to reflect the increased share count.
From the company's perspective, there is no cash outflow since bonus shares are issued from retained earnings, maintaining the overall capital while adjusting the per-share value to account for the increased share count.
Right Shares - Right shares are additional shares offered to existing shareholders at a discounted price, usually in proportion to their current holdings. Shareholders have the right to purchase these shares before they are offered to the public. Right shares are typically issued when a company wants to raise additional capital, giving existing shareholders the opportunity to increase their investment at a discounted rate. Shareholders can buy right shares at a lower price than the current market price, which can be advantageous.
However, they are not obligated to buy these shares and can choose to sell their rights instead. If they do not participate, their ownership percentage in the company may be diluted. Issuing right shares brings in additional cash to the company, which can be used for expansion, debt repayment, or other purposes. The company's equity base expands as a result of the increased number of shares, affecting its debt-to-equity ratio.
Bonus shares are a way for companies to reward shareholders by issuing free shares, while right shares provide an opportunity for existing shareholders to buy additional shares at a discount, usually to help the company raise new capital. Both bonus shares and right shares have different effects on the shareholders and the company’s financial position.
What are the applications?
Bonus Shares and Right Shares: Applications
Bonus Shares Applications - Companies often issue bonus shares as a way to reward shareholders without paying out cash dividends, appealing to those looking to increase their equity holdings without additional investment. By issuing bonus shares, a company can increase the total number of shares in circulation, enhancing market liquidity and making shares easier to trade.
This approach is especially beneficial for companies with high share prices, as it effectively reduces the per-share price, making the stock more accessible to a broader range of investors. Issuing bonus shares allows a company to retain earnings and conserve cash reserves, rewarding shareholders while maintaining funds for operational or growth needs.
This practice can signal strong financial health to the market, boosting investor confidence, and is often used by companies in mature industries that consistently generate profits and build up reserves.
Right Shares Applications - Right shares are commonly used by companies looking to raise capital for expansion projects, such as opening new facilities, acquiring other companies, or investing in research and development, allowing them to fund growth without incurring additional debt.
Companies may issue right shares to raise funds specifically for debt reduction, improving financial ratios such as the debt-to-equity ratio. In some cases, right shares can fund specific projects or investments, like entering a new market or launching a new product, providing necessary capital while giving existing shareholders the chance to maintain or increase their stake. Issuing right shares also helps strengthen a company’s balance sheet by increasing equity and reducing reliance on external financing, which is especially beneficial in uncertain economic environments.
Furthermore, by offering right shares, companies give existing shareholders the first opportunity to buy additional shares before they are offered to the public, preserving the ownership structure and helping shareholders avoid dilution by increasing their investment.
Bonus shares are primarily used as a reward mechanism and a tool to increase share liquidity, while right shares are utilized as a method of raising additional capital for strategic initiatives like expansion, debt reduction, or new investments. Both mechanisms play crucial roles in a company’s financial strategy, as bonus shares and right shares offer unique benefits to the company and its shareholders.
Let’s examine the pros and cons of these financial tools:
Bonus Shares and Right Shares: Pros and Cons
Bonus Shares
Pros - Bonus shares are essentially a reward to shareholders, providing additional shares at no cost, which can enhance market liquidity by increasing the number of shares available for trading. This issuance also serves as a positive signal of the company's strong reserves and future confidence. Since these shares are given instead of cash, the company preserves its cash reserves, supporting financial stability.
Cons - While shareholders receive more shares, the immediate investment value remains the same as the share price adjusts downward proportionally. This also dilutes earnings per share (EPS), as net earnings are spread across a larger share pool, potentially lowering the stock's perceived value. Consequently, since no new funds are raised, the company does not receive capital to support growth or financial needs, which could limit opportunities requiring cash; think expansion or debt repayment.
Right Shares
Pros - Right shares offer several advantages. Shareholders have the opportunity to buy additional shares at a discounted rate, which can be financially beneficial. For the company, issuing right shares raises additional capital that can be used for expansion, debt reduction, or other financial needs. Shareholders who purchase these shares can maintain their ownership stake, avoiding dilution of their equity in the company.
Cons - Not exercising right shares can lead to ownership dilution, reducing shareholder influence. Frequent right issues might signal operational cash struggles, hurting investor confidence. Unlike bonus shares, right shares require additional cash, which isn't feasible for all investors. Although discounted, right shares can still pressure the share price as they increase market supply.
Bonus shares are generally beneficial for shareholders who want to increase their holdings without investing additional funds, while right shares offer the opportunity to buy more shares at a discount but require a cash investment and can lead to dilution if not exercised. For the company, bonus shares and right shares are strategic vehicles for rewarding shareholders, increasing share liquidity, and raising capital for growth pursuits.
