PART 4: CAPITAL STRUCTURE AND PAYOUT POLICYBonus Shares
Issuing bonus shares involves the payment to existing shareholders of a dividend in the form of extra
shares. For example, if a company declares a 20% bonus share issue, it will issue 20 new shares for
every 100 shares that an investor owns. Companies often issue bonus shares as a replacement for, or
a supplement to, cash dividends. However, bonus shares do not necessarily increase a shareholder’s
wealth. If a company completes a 20% bonus share issue, and nothing else about the company changes,
then the number of outstanding shares increases by 20%, and the share price drops by about 16.7%
to 83.3% of its original price (100% ÷ 120% = 83.3%). Thus, the net effect on shareholder wealth is
neutral; the bonus shares neither increase nor decrease the value of investors’ shareholdings – that is,
120% shares × 83.3% price = 100% of original value. In other words, shareholders receiving bonus shares
maintain a constant proportional share of the company’s equity.Share Splits
Share splits, like bonus shares, should have mostly cosmetic effects on a company. When a company
executes a share split (referred to as stock splits in the US), its share price declines, because the number of
outstanding shares increases. For example, in a 2-for-1 split, the company doubles the number of shares
outstanding, but the share price falls to approximately half its previous level. Managers who implement
share splits generally say they are trying to restore the per-share price of the company’s equity to within
a ‘preferred’ trading range that individual investors desire. Such managers believe that they can achieve a
higher overall company value by keeping the share price low enough to appeal to retail investors.
Intuition suggests that share splits should not create value for shareholders. After all, if someone
gives you two $5 bills in exchange for one $10 bill, you are no better off. A share split should also have
no effect on the company’s capital structure, because it changes the number rather than the value of
outstanding shares. In spite of this logic, research shows that share splits increase the market value of a
company’s equity by about 2.5%. In other words, if a company whose shares trade for $100 announces
a 2-for-1 split, research shows that the share price will fall to roughly $51.25 (so two shares are worth
$102.50).exampleMost established US public companies routinely
split their shares to keep the price within a
perceived optimal range. General Electric (GE), a
company that has paid a cash dividend each quarter
for over 100 years, is perhaps the best example of
this policy. GE’s shares were first offered for sale
at US$108 per share in 1892. Had GE not split itsshares repeatedly over the years, the price per
share would have been over US$92,000 by 2011.
The price of the voting shares (A shares) of the
most famous company that refuses to split its
voting shares, Berkshire Hathaway, was US$119,164
on 18 May 2011 and had risen to US$224,880 by
7 February 2015.Most share splits increase the number of shares outstanding, but companies sometimes conduct
reverse share splits, replacing a number of outstanding shares with just one new share. For example, in a
1-for-2 split, one new share replaces two old shares; in a 2-for-3 split, two new shares replace three old
shares; and so on. A company whose shares sell at a very low price may initiate a reverse share split to
increase its share price and avoid being delisted due to any minimum share price requirement of the
exchange where the share trades.bonus share issue
The payment to existing
shareholders of a dividend in
the form of shares
share split
A transaction in which a
company increases the
number of outstanding shares
by issuing new shares to
existing shareholders
reverse share splits
Occur when a company
replaces a certain number of
outstanding shares with just
one new share to increase the
share price