What Are Bonus Shares
When companies don't have a surplus liquid fund to pay dividends, they issue bonus shares to their investors. These free additional shares are issued in proportion to the shares held by the investors. For example, if investors are holding 10 shares, they will get 10 additional shares. On the contrary, even when there is sufficient liquid fund, companies still give bonus shares just to save the heavy taxes levied on dividends. They do so because of the capital reserve built by keeping a portion of profit aside over the years. This also helps them in increasing stock liquidity and encouraging people for buying shares.
Impact of bonus share on share's price
When companies announce the bonus issue, they adjust the share price in proportion to the bonus ratio. For example, if the share price before the bonus is Rs. 100, and the company is giving bonus shares at 1:1 ratio, then post-bonus, the price of the share will be Rs. 50. This keeps the total market value (2 x 50 = Rs. 100) neutral. Moreover, it also increases the share capital of the company while its net assets remain the same. And as no cash payments are involved, there is no change in liquidity.
Conditions to be fulfilled by companies for bonus issue
The Articles of the company must authorise the bonus issue.
A resolution needs to be passed at the general meeting by the company's Board of Directors and the same needs to be ratified by the shareholders.
The Controller of Capital Issues has to sanction the resolutions irrespective of the amount involved.
Companies need to follow guidelines set by the SEBI.
Companies need to get the consent of the Reserve Bank before a bonus issue.
An amendment to the Memorandum of Association needs to be done if the total share capital is exceeding the authorized share capital because of a bonus issue.