Right shares and bonus shares are two common ways through which companies can raise equity capital. Right shares allow existing shareholders to purchase additional shares at a discounted price compared to the market value. This gives them the option to maintain or increase their ownership in the company.
On the other hand, bonus shares are issued to existing shareholders for free, in proportion to their existing holdings. While right shares involve a capital infusion from shareholders, bonus shares are essentially a capitalization of the company’s reserves.
Comparison Chart
| Parameter of Comparison | Right Shares | Bonus Shares |
|---|---|---|
| Purpose | Raise capital for the company | Reward existing shareholders |
| Cost to shareholder | Discounted price (usually) | Free |
| Impact on ownership percentage | May dilute ownership (if not exercised) | Does not dilute ownership |
| Impact on share price | May decrease slightly | May decrease slightly |
| Source of shares | New shares issued by the company | Created from company’s profits or reserves |
| Shareholder option | Can be exercised, renounced, or sold | No option – automatically credited |
| Timing | Issued at any time | Typically during profitable periods |
What are Right Shares?
Right Shares are a type of business shares that a company issues to its already existing shareholders at a lesser cost. The shareholders have the option to accept or decline the offered deal. They can even sell these shares in the market to someone else.
These shares can only be bought on specific terms and conditions. There is a minimum subscription that the buyer has to meet. Companies have to release Right Shares when they need to add more money to their already-held revenue.
As for the paid-up value of these shares, the company is entitled to pay half or the total amount – in varying situations. Basically, they are created as additional shares to be given out to the already shareholders to maximize the accumulated revenue.
Experts suggest that such shares have a decremental impact on the market shares’ value if they are sold by those who buy them. They work well as long as they are in the hands of their buyers. This makes Right Shares one of the significant financial moves of a business.
Mechanism of Right Shares
When a company decides to issue right shares, it essentially grants its current shareholders the opportunity to buy a specified number of new shares at a predetermined price, at a discount to the market price. This is done through the issuance of rights entitlements, which are distributed based on the proportion of shares held by each investor. Shareholders can either exercise these rights by purchasing the additional shares or choose to sell their rights in the open market.
Purpose and Benefits
Right shares serve various purposes for both the company and its shareholders. For the company, it is a means of raising fresh capital for expansion, debt reduction, or other corporate initiatives. it enables the company to involve existing shareholders in its growth plans and maintain their proportional ownership.
For shareholders, the issuance of right shares presents an opportunity to increase their stake in the company at a discounted rate. This can be particularly appealing as it allows shareholders to benefit from the potential appreciation of the stock, given the discounted purchase price.
Key Considerations
Before participating in a right share offering, investors should carefully evaluate several factors. These include the subscription price compared to the current market price, the company’s financial health and growth prospects, and the overall market conditions. investors must assess their own financial position and investment goals to determine whether exercising their rights aligns with their strategy.
Risks and Challenges
While right shares offer an avenue for companies to raise funds, they are not without risks. The potential dilution of ownership can be a concern for existing shareholders, especially if the new shares are issued at a significant discount. the success of a right share issuance depends on market conditions and investor sentiment.
Examples of Right Shares
- Reliance Industries (2008): In 2008, Reliance Industries issued Right Shares to its existing shareholders, giving them the privilege to buy additional shares at a discounted price. This move aimed to raise capital for expansion projects.
- Tata Motors (2015): Tata Motors offered Right Shares to its shareholders in 2015, allowing them the option to purchase more shares at a predetermined price. The funds raised were intended to support the development of new models and technological advancements.
- ICICI Bank (2007): ICICI Bank opted for a Rights Issue in 2007, offering shares to its existing shareholders. This strategy helped the bank secure additional funds to reinforce its capital base and maintain financial stability.
- Hindustan Unilever (2017): Hindustan Unilever issued Right Shares to its shareholders in 2017, enabling them to buy more shares at a discounted rate. The proceeds were directed towards various business initiatives and enhancing market presence.
- Infosys (2004): Infosys, in 2004, conducted a Rights Issue, granting existing shareholders the opportunity to purchase additional shares. The capital raised was used to invest in research and development, strengthening the company’s technological capabilities.
What are Bonus Shares?
Bonus Shares are a given privilege for the existing shareholders of a large business. They are issued without any additional cost to be paid by the buyer. Every business has its own date of issuing Bonus Shares to its members in stakes.
The primary purpose of these shares is that when a company wants to refrain from paying dividends to its shareholders, it gives out Bonus Shares. In this way, both the company and shareholders benefit. Experts consider them a financial strategy to regulate its revenue and expenditures.
No subscription is required by the company to get Bonus Shares. They are feasibly issued to the shareholders who do not get dividends out of the profits. In place of money, they get more shares. Hence, their investment in the business is multiplied.
The effect of Bonus Shares on the shares market is that it always reduces the value; however, companies try to regulate this decrement by maintaining a proper ratio. This is a financial strategy of a business to avoid paying dividends and increasing shares of shareholders.
Mechanism of Bonus Shares
1. Capitalization of Reserves
Bonus shares are issued by capitalizing a company’s reserves. Rather than distributing profits as dividends, a company may opt to convert its accumulated reserves, such as retained earnings or share premium, into additional shares. This process does not involve any cash outflow, making it an attractive option for companies looking to reward shareholders without impacting their liquidity.
2. Proportional Allocation
The allocation of bonus shares is proportional to the existing shareholding of each investor. For example, if an investor holds 100 shares and the company declares a bonus issue on a 1:1 basis, the shareholder will receive an additional 100 bonus shares. This ensures that the ownership percentage of each shareholder remains unchanged.
Rationale Behind Bonus Issues
1. Enhancing Share Liquidity
Issuing bonus shares increases the number of outstanding shares in the market, thereby enhancing liquidity. This can attract more investors and potentially lead to a broader shareholder base.
2. Signal of Confidence
Companies issue bonus shares as a signal of confidence in their financial performance and future prospects. The act of capitalizing reserves to reward shareholders implies that the company believes it can generate sustainable profits in the long run.
Impact on Financial Statements
1. Share Capital and Reserves
The issuance of bonus shares affects the company’s financial statements. The share capital account on the balance sheet increases, reflecting the additional shares issued. Simultaneously, the reserves decrease as they are utilized to create the bonus shares.
2. Earnings per Share (EPS) and Price per Share
While bonus shares do not impact the net worth of shareholders, they dilute earnings per share. This is because the same amount of earnings is distributed among a larger number of shares. However, the market price per share adjusts to reflect the bonus issue, mitigating the impact on individual shareholders.
Tax Implications for Shareholders
1. Tax-Free for Shareholders
In many jurisdictions, the distribution of bonus shares is considered a tax-free event for shareholders. Investors do not incur any tax liability until they sell the bonus shares.
2. Capital Gains on Bonus Shares
When bonus shares are eventually sold, capital gains tax may be applicable. The capital gains are calculated based on the market value of the bonus shares at the time of sale.
Examples of Bonus Shares
- Wipro (2010): Wipro declared a Bonus Issue in 2010, issuing additional shares to existing shareholders without any cost. This move aimed to reward loyal investors and enhance the company’s equity base.
- HDFC Bank (2017): HDFC Bank announced a Bonus Issue in 2017, providing shareholders with additional shares as a gesture of appreciation. The bonus shares were distributed in proportion to the existing shareholding.
- Bharti Airtel (2004): Bharti Airtel issued Bonus Shares in 2004, increasing the number of shares held by existing shareholders without any additional payment. This strategy aimed to improve liquidity and make the stock more attractive.
- Maruti Suzuki (2018): Maruti Suzuki carried out a Bonus Issue in 2018, rewarding shareholders with additional shares in a certain ratio. The objective was to boost shareholder value and create a positive sentiment in the market.
- Hindalco Industries (2006): Hindalco announced a Bonus Issue in 2006, granting shareholders additional shares without any cost. This move was part of the company’s strategy to strengthen investor confidence and improve its market position.
Difference Between Right Shares and Bonus Shares
- Purpose:
- Right Shares: Issued to existing shareholders, giving them the option to buy additional shares at a predetermined price. The purpose is to raise additional capital.
- Bonus Shares: Issued to existing shareholders for free, based on their current holdings. The purpose is to capitalize on retained earnings and strengthen investor relations.
- Issuance:
- Right Shares: Require shareholders to exercise their rights by either buying the shares or selling their rights in the market.
- Bonus Shares: Automatically distributed to existing shareholders in proportion to their current holdings without any monetary obligation.
- Pricing:
- Right Shares: Offered at a discounted price compared to the market value, encouraging existing shareholders to subscribe and invest more capital into the company.
- Bonus Shares: Issued free of charge, with no cost to existing shareholders, as they are a form of capitalization of reserves.
- Shareholder Dilution:
- Right Shares: May lead to dilution if existing shareholders choose not to exercise their rights, resulting in a higher share count and potentially reducing individual ownership percentages.
- Bonus Shares: Generally do not cause dilution as they are distributed free of charge to existing shareholders without altering the overall share capital.
- Impact on Financials:
- Market Perception:
- Right Shares: Viewed as a capital-raising strategy, signaling the company’s intention to fund expansion or meet financial obligations.
- Bonus Shares: Perceived positively by shareholders as a gesture of sharing profits, reflecting financial stability and confidence in the company’s future prospects.
- Regulatory Approval:
- Right Shares: Typically require regulatory approval before issuance to ensure fairness and adherence to market regulations.
- Bonus Shares: Usually do not require regulatory approval as they involve the distribution of accumulated profits to existing shareholders.
- Tax Implications:
- Right Shares: Generally result in a capital gain or loss for shareholders depending on the eventual sale of the acquired shares.
- Bonus Shares: Usually not subject to immediate taxation for shareholders, as they represent a capitalization of reserves rather than a direct financial gain.