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Reader Comment: Are Bonus Shares Still Feasible?

New comment on a Bonus Shares Post, by an anonymous reader:

1. I understand that (at least until recently) it has been very common for Indian companies to issue bonus shares. Companies in India seem more inclined to issue bonus shares than companies in other countries. I understand that this is because, historically, Indian shareholders have obtained very favourable tax treatment in respect of bonus shares issued by Indian companies. However, I see that you have posted a note saying that “It Used to be legal, now it has been plugged. The following article is only useful for historical notes, and is no longer applicable – Deepak, 2007.” My question is: Now that the tax benefit has been “plugged”, will Indian companies be less inclined to issue bonus shares than they have been in the past? Or, is it the case that there other good reasons for issuing bonus shares which mean that Indian companies are likely to continue issuing bonus shares as often as they have in the past?

Bonus issues have also been favoured for the impression they give: that they are a “bonus”, a free incentive. This is not true anymore as the share price goes down by the bonus ratio, but sentiment still indicates that people expect the share price to come back to the original price at some point!

Bonus shares are one way to reduce share price without splitting the share. So for a company whose face value is small – say Rs. 1 – they can’t split any further, meaning if they want to keep the share price small enough for retailers to be interested, a bonus would work well. Remember that bonuses only work when the company has huge free reserves, but that’s not really a problem for a well established company trading in the 1000s of rupees per share.

2. When Indian companies issue bonus shares, do they usually issue bonus shares “at par value”, or instead, do they usually issue bonus shares “at a premium”? Also, does the recent “tax plug” referred to above, affect what is likely to happen in this regard in the future?

Bonuses are usually issued at zero cost, but the face value is the same as any other share. The reason they are considered a “bonus” is that the company capitalises it’s free resources, so it doesn’t expect you to pay even the face value. You can’t have different par values (face values) for shares of the same company. So in this regard there will be no change.

There’s something else called “rights” issues, which are usually at a premium but a discount to current market price. Entirely separate discussion and I will post more details on this later.

  • Sujit says:

    >Hi Deepak,

    I have a question regarding Morgan Stanley Growth Fund going open.
    This closed ended fund is going open. And will delist from stock exchanges. What does it mean for me as an investor?
    The news talks about an open offer. What does it mean by open offer?
    It will be great if you can explain this.

    Thank You,

  • Gunjan says:

    >Large reserve in company’s balance sheet could be sign of (a) safety for unfavorable time that may come in near future or (b) plan to expand by may be investing in infrastructure, future business plans, R & D etc etc.

    When company issues bonus shares (and there by moving reserves to capital) its an indication of management’s confidence to serve large equity, and ability to increase its profit and to distribute dividends among all these increased shares in future.

  • Deepak Shenoy says:

    >Sujit: Will write a post about this.

    Gunjan: You are right, though in this day and age, capitalisation of free reserve is not a big deal, since there is no transfer of money – just movement from one account to the other. Dividends should be a function of percentage of profit, not of face value – the face value in most shares is insignificant compared to the market prices, and dividend yields are usually 2-3%, so maintaining dividend may not be that big a problem.