Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends, but are converted into free shares.
The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
Companies issue bonus shares to encourage retail participation and increase their equity base. When price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. Increase in the number of shares reduces the price per share. But the overall capital remains the same even if bonus shares are declared.
Advantages of bonus shares:
By issuing bonus shares, shareholders are to be satisfied when the company cannot pay dividend in cash due to shortage of liquid funds, i.e., profit can be distributed without distributing the liquid resources, viz. cash.
Shareholders are to be satisfied, particularly when the company does not prefer to pay dividend in cash for the purpose of either its expansion or its working capital or any other specific purpose, such as any particular programme of diversification or modernisation.