(^338) Financial Management
TABLE Effect of Bonus Shares and Shares Splits
From Table it is clear that a share split is similar to bonus issue from the economic point
of view though there are some difference from the accounting point of view. In the
equity portion of the firm, a bonus issue reduces the retained earnings and correspondingly
increases paid-up equity and share premium, if any, whereas stock/share split has no
such effect. The economic effect of both is to increase the number of equity shares
outstanding.
As pointed out earlier, no major economic benefit results from bonus shares and share
splits. Yes, certain advantages are associated with them. In the first place, the issue of
bonus shares / share splits would have the effect of bringing the market price of shares
within more popular range as a result of larger number of shares outstanding. The
larger number of outstanding shares will also promote more active trading in the shares
due to availability of floating stock. Yet another advantage might relate to the
informational content of bonus/split announcement. The announcement is perceived as
favourable news by the investors in that with growing earnings, the company has bright
prospects and the investors can reasonably look for increase in future dividends.
Moreover, it enables the conservation of corporate cash. If the bonus share is an effort
to conserve cash for profitable investment opportunities, the share prices will tend to
rise and the shareholders benefit. However, if the move to conserve cash relates to
financial difficulties within the firm, the market price will most likely react adversely.
Finally, bonus / split announcements improve the prospect of raising additional funds
particularly through the issue of convertible debentures.
Repurchase of Stock
As an alternative to paying cash dividends, a company may distribute income to its
- Equity portion before the bonus issue:
Equity share capital (30,000 shares of Rs.100 each)
Share premium (@ Rs.25 per share)
Retained earnings
Total equity
Rs. 30,00,000
7,50,000
62,50,000
1,00,00,000- Equity portion after the bonus issue (1 : 2 ratio):
Equity share capital (45,000 shares of Rs.100 each)
Share premium (45,000 shares X Rs.25)
Retained earnings (Rs.62,50,000 – 15,000 shares × Rs.125)
Total equity
45,00,000
11,25,000
43,75,000
1,00,00,000- Equity portion before the share splits (10 : 1 ratio):
Equity share capital (3,00,000 shares of Rs.10 each)
Share premium
Retained earnings
Total equity
30,00,000
7,50,000
62,50,000
1,00,00,000