Methods of raising additional equity financeNote that the conversion of retained profits into shares leaves the uses of funds
totally unaffected. It also leaves completely untouched the equity figure: in other
words, the contribution of the ordinary shareholders is not altered by the bonus issue.
All that will occur is that for every two shares held before the bonus issue, each share-
holder will hold three after it. As with splitting, the economic effect of a bonus issue
should logically be zero. If in this example the price of an ordinary share were £1.80
before the issue, it should be £1.20 (that is, £1.80 ×–^23 ) afterwards.
If they have no economic consequences, why do businesses make bonus issues? Do
directors believe that shareholders will be fooled into thinking that they have got
something for nothing? If so, the evidence (discussed in Chapter 9) suggests that those
directors are wrong. It may be that bonus issues are intended to transmit information.
They are sometimes thought to indicate a confidence on the part of management in
the investments that it has made. A third possible reason is, as with splits, simply to
reduce the unit price of the shares to (what management may regard as) a more mar-
ketable size.
TheRoyal Bank of Scotland Group plcmade a two-for-one bonus share issue in
2007 in an attempt to increase the liquidity of its shares.Factors to consider in respect of raising finance by retention of profits
Does dividend policy affect the net wealth of the shareholder?
If it does, then retaining one proportion of the profit, rather than another proportion,
will have some effect on the sum of the dividend paid and the ex-dividend price of the
share, that is, on the net wealth of the shareholders. We shall review the debate and
evidence on this topic in some detail in Chapter 12.No issue costs
Other means of raising additional equity have explicit issue costs not applicable to
retained profits.Profits are uncertain
Once the need for raising further finance has been identified, there is no guarantee that
sufficiently large profits will subsequently be made to meet the requirements. On the
other hand, once the funds have been generated from profits, their existence is certain
and their retention just a matter of a management decision. This latter point contrasts
with other methods of raising equity finance.No dilution of control
Retaining profits does not alter the voting strength of any individual shareholder.Equity issues to the public
Before we start to consider share issues in detail, it will be helpful to distinguish
between issues that are made by businesses that have just been listed by the London
Stock Exchange and are making their first significant issue of shares to the public,
known as initial public offerings(IPOs), and further issues made by businesses at some
time after their listing, known as seasoned equity offerings(SEOs).‘
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