Understanding the hidden cost associated with bonus share

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Bonus shares are a common topic in Nepal's stock market, offering excitement among investors. Investors are also usually misguided by saying bonus shares are issued free of costs. The issuance of bonus shares to meet specific requirement can be commendable but issuance of bonus shares in the name of just increasing share do cost shareholders wealth and company's resources. This article takes a deep drive into the cost of bonus shares and procedures and impacts of bonus shares.

What is bonus share?

A bonus share is an additional share issued by a company to its existing shareholders, in proportion to their holdings. This essentially increases the number of shares outstanding for the company.

Why do company issue bonus share?

Companies may issue bonus shares for several reasons:

  • Rewarding Shareholders without Cash: When a company has good profits but limited cash reserves, issuing bonus shares can be a way to reward shareholders without depleting their cash flow.
  • Increasing Share Affordability: By increasing the number of shares outstanding, bonus shares can potentially make individual ownership more accessible, attracting a wider range of investors.
  • Regulatory Compliance: In some cases, companies may need to issue bonus shares to meet regulatory requirements regarding minimum capital levels.

 Are There Any Costs Associated with Bonus Shares?

Issuing bonus shares might seem free for shareholders, but it actually comes with hidden costs. These costs can be avoided by keeping the profit in reserves instead of issuing bonus shares. The extra expenses incurred by the company ultimately affect shareholders, as the company's wealth and resources belong to them.

  • Legal Costs: Companies incur listing and renewal charges with the stock exchange for the additional shares issued in the form of bonus shares. ((Refer appendix 1 for detail)
  • Taxation Costs: A 5% dividend tax is levied in Nepal on bonus shares.
  • Administrative Costs: Managing the issuance of bonus shares requires administrative expenses for the company.
While analyzing the cost associated with bonus shares, I believe that any expense exceeding at least 5.05% of the paid-up value that a shareholder obtains cannot be considered free. Despite the apparent increase in the number of shares, shareholders gain nothing in terms of portfolio value appreciation due to the subsequent adjustment in market price.
 

What is the procedures to issue bonus share?

As per section 83 of the companies act,2063, a company is required to pass special resolution in the general meetings of the company to issue bonus shares.

The provision contained in the section 74(3) of the same Act requires the vote of 75% of the total attendee in general meetings to pass special resolution.


What is the impact of issuance of bonus share?

As shareholders, we own the residual interest in a company. Whether the company retains profit by issuing bonus shares or not, it doesn't directly affect shareholders' wealth. Some experts suggest that bonus shares are merely an accounting entry transferring reserves to capital, with no direct impact on shareholder wealth. The impact of bonus shares can be viewed as:

Positive View:

·       Bonus shares directly increase the number of shares a shareholder owns in the company, proportionally raising their ownership stake. This can be psychologically appealing to investors, fostering a sense of deeper involvement and potential future benefits.

·       The announcement of bonus shares can sometimes trigger positive sentiment in the market, leading to increased investor interest and potentially driving up the share price. This can benefit existing shareholders by appreciating the value of their holdings.

Negative View:

·       Bonus shares increase the number of outstanding shares without altering the company's overall profit. Consequently, financial metrics like earnings per share (EPS) and book value per shares, gets diluted, making company appearing less profitable. This may impact price and confidence of the potential investors.

·       Since companies are not obligated to pay dividends on bonus shares, some argue that these shares don't directly translate into increased income for shareholders. This can be a concern for investors seeking regular dividend payouts as a source of income. 

Impact on market capitalization 

In reality, Bonus share don't affect company's market capitalization since they increase the number of shares and decrease the price proportionately. However, bonus shares can make the stock more affordable, attracting to new investors and potentially leading to a price increase. Nonetheless, it also possess the risk of decline in share prices due to oversupply of shares.

Conclusions

Bonus shares themselves are not inherently good or bad for investors. It's crucial to understand the company's motives behind issuing them, analyze the potential financial impact, and consider the broader market context before making any investment decisions. By carefully evaluating these factors, investors can make informed choices regarding bonus shares and their overall investment strategy in the Nepalese stock market.

Appendix 1: Securities Listing and renewal charges 

S.n

Share Capital

Listing charge

Annual Charge

1

Below 50 crore

Minimum of 0.1% or R.s 150,000

R.s 50,000

2

50 crore or above

Minimum of 0.05% or R.s 250,000

R.s 100,000

(Refer: annexure 3 of SEBON Bylaws for securities listing for detail) 

Application charge of R.s 15,000 shall be charged for the procedures.


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