Why are bonus shares issued and what are their advantages?

Rajeev posted the following comment yesterday:

Rajeev Srivastava May 22, 2013 at 6:06 pm [edit]

Hi Manshu,

I am curious to know about implications of bonus issue of shares. Is there any existing post on this at onemint?


This is a good topic for a post, and I thought I would broaden the scope a little and answer why a company issues bonus shares and then my opinion on the implications of a bonus issue. I use ‘opinion’ because I’m not going to use any data to share what I think about bonus issues.

Why does a company issue bonus shares?

When a company issues a bonus shares the price of its existing shares come down by about the same ratio as the bonus shares that have been issued. So if the bonus issue is 1:1 which means they are issuing one additional share for each existing share, the market price of the share will roughly halve.

When the price falls, the liquidity of the share improves, and that to me is the primary reason for a company to issue bonus shares. I think an example shows this quite well. What if a single share of a company was Rs. 93,26,940 – how many people do you think will trade in this share?

What if the same share was worth Rs. 6,177? Wouldn’t a lot more people now trade in this share?

The two prices I took were the price of Berkshire Hathaway’s class A and class B shares. Warren Buffett’s Berkshire Hathaway never paid a dividend, issued a bonus, or conducted a split for decades and as a result their class A share is worth roughly $167,000.

I feel that the primary reason for all splits and bonus issues is allowing the share price to fall in value to facilitate trading.

What are the advantages of issuing bonus shares?

Facilitating trading is the one big benefit of issuing bonus shares, but this is from the perspective of the company, how do investors benefit from bonus issues?

People view bonus issues as a positive action, but I’m not sure why that is. As soon as the number of shares increase, the value of each share goes down in value, so theoretically there are no gains to be had just because of a bonus issue.

I came across a Business Today article about the features and advantages of bonus issues and according to the data they analyzed – there is a good chance that the companies that issued bonus shares rise in the year after the issue. You can read the whole article to see the data they looked at and then their interpretation of it. My own opinion on this is that this is one of those things where correlation does not always mean causation.

The companies they looked at rose, but what about other similar companies? How much did the companies that rose actually rose and for how long? They stopped after a year but what after that year?

I don’t know what the answer to these questions is but I’ve never come across anything that showed without doubt that bonus issues  are an indication that the company will outperform the market.

19 thoughts on “Why are bonus shares issued and what are their advantages?”

  1. Hi, great post. Really helpful. Most people gets confused between a bonus and split. Bonus is excellently described here. Thanks for sharing.

  2. The reason why people love bonus share is the fact that selling bonus share does not attract tax implications. On top of that the existing share price gets 50 percent of the bonus issue is 1:1. So if the investment is for short term then you can claim loss of the initial shares and bonus shares don’t attract taxes. So I hope it helps .

  3. Share holders benefit in 2 ways,
    – most of the times the share prices goes back to the original within a year
    – and they get higher ( inline with bonus ratio) dividends from the following year

  4. I think you are quite right that companies issue bonus shares to improve liquidity. Bonus shares also increase the market cap.

    However, by increasing the number of shares in circulation, the EPS actually falls. Investors value a company according to its EPS. When a market cap increases, it may put the stock in a position where it becomes fully valued, hence deterring further investments.

    Even crazier, some companies buyback the shares after bonus issue. This is akin to spending money for nothing.

    There is a reason why US does not have bonus issues. First it does not help the EPS. Secondly, it does not help the SP.

    Stock splits are different. It improves the liquidity but it does not increase the market cap.

  5. If the value of the shares is going to be reduced to half in case of 1:1 bonus shares,then what is the difference between splitting the shares by reducing the face value and issue of bonus shares. My understanding is in first case face value of the shares remains unchanged where as in second case face value gets reduced.

  6. Sir how can we know about company which could issue bonus in future?? I mean is there specific parameters we can check in balance sheet of company and predict the future candidate of bonus share. If any one knows such company please share here that can be probable candidate for bonus issue

    1. There is really no way to tell in advance whether a company is going to issue bonus shares or not. Perhaps one way to telling that is to see whether the company is in general performing well or not.

      To me, however there is no point in trying to predict if a company will issue bonus shares or not, it isn’t going to tell you anything useful.

  7. I have a general query here. Let us say a company offers 1 bonus share for every 2 shares, if I hold 5 of them then how much will I recieve ? Is it only 2 bonus shares ? If yes what about the fifth share I have ? Does it not have any value ? Usually how does companies these sort of situations. Please explain.
    Thanks, Karthik

  8. Had a question , do the promoters also get bonus shares when the bonus share are declared. If yes then they are the ones who benifit the most as they have got the shares at face value.

    1. Yes they also get the shares, but they don’t benefit more than others since everyone gets shares for free and then everyone gets the same market price as others.

  9. While the analysis will be spot on for share split, won’t for bonus the equity base increase?
    That is some reserves would be capitalized to create the new shares to be distributed to shareholders. Also wouldn’t the ratios having equity in denominator also change.

    1. Yes, you are correct. The equity base rises and the capital increases. The reserves will go down as some of the reserves will be capitalized to issue shares, and then the EPS will decline as the number of shares will increase. There are several other effects on ratios as well and it depends on whether equity or number of shares are used.

  10. Could you explain which is more benificial to the investors split or bonus. I assume bonus is benificial as face value of the stock is not changed.

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