On December 31, 1600, East India Company was formed by the grant of a charter by the English Parliament. Though not the first joint stock company to be formed, it was perhaps the most influential company in the global corporate history, surviving for over 270 years before being liquidated on June 1, 1874. During this period, East India Company initiated many innovative practices that are prevalent in the corporate world even today. One among them is the practice of issuing Bonus Shares.
The Concept
Bonus shares is a method of rewarding shareholders. Rather than pay out cash to its shareholders, which is the normal form of rewarding shareholders by paying dividend, in Bonus shares, shareholders are given fully paid equity shares in the company. This ensures that the company rewards its shareholders without paying them cash, despite which shareholders can get cash if they so desire by selling their bonus shares received in the stock market.
The First of First
One of the earliest, if not the first recorded event of a bonus issue is in the year 1682, when East India Company doubled its share capital by issuing one share for every share held. It did this by extinguishing the liability of £50 per share that had not been called up by the company, by converting partly paid shares of £50 into fully paid shares of £100 each without receiving any money from its shareholders.
In the process it paid a 100% dividend (£50 dividend on a £50 pound share). A critical factor influencing this decision was that despite profits, liquidity was tight in the company with adequate surplus cash not being available to pay this dividend, even as the need to reward shareholders and retain their support remained high.[1]
The issue of Bonus shares by East India Company proved a success as the company was able to maintain or increase the dividend payments over the next ten year period on their increased capital base. This contributed to issue of bonus shares being seen as an additional avenue for rewarding shareholders, in addition to payment of annual dividend.
The other leading companies of that time too issued bonus shares making this practice firmly entrenched. They even went a step further when Hudson Bay Company in the year 1690 issued 2:1 bonus shares i.e. two shares for every one held, which was followed by the Royal African Company in the subsequent year, when it issued 3:1 bonus shares in 1691, resulting in establishing the use of bonus shares as an accepted practice to reward shareholders.
Rationale for Bonus Shares
- In a jurisdiction where dividend is taxed either in the hands of the company declaring the dividend or in the hands of recipients, issue of bonus shares combined with buy-back of shares by the company can be an efficient tax planning device, especially if the sale of bonus shares are not taxed as long term capital gains or are taxed at concessional rates.
- A company that is profitable and growing rapidly, which needs additional investment for growth in the form of fixed assets or working capital can use bonus shares to reward its shareholders without parting with liquid cash need for growing their business.
- High share prices can psychologically deter investors from buying shares. Judicious use of bonus shares can reduce the share price without correspondingly reducing market capitalization, thereby making it attractive for investors to buy the shares.
- Some companies have used periodic issue of bonus shares as a method to reward shareholders for a combination of reasons and the investor expectations also play a role in some bonus issues even though there may not be any economic rationale for it.
Companies Act, 2013
Section 63 of the Act permits a company to issue bonus shares by using its securities premium account, capital redemption reserves and free reserves. However, a company is not permitted to issue bonus shares in lieu of dividend. Once a company has announced the decision of its Board to issue bonus shares, this decision cannot be withdrawn.
The Act also protects the interest of lenders and employees by permitting bonus shares to be issued only if the company is not in default of interest or principal repayments on its loans and payment of statutory dues pertaining to employees.
Current Usage (In 2017 till July)
Rewarding shareholders by issue of Bonus shares is a common practice today. Prominent issuers of bonus shares in 2017 include companies like Biocon, BPCL, HPCL, ICICI Bank, L&T and Wipro among other.
[1] Robert Scott, W, The Constitutions and Finance of English, Scottish and Irish Joint Stock Companies Volume 1, Cambridge University Press, 1912, p 304