Corporate Action – Bonus / Split / Rights Issue
Investors frequently come across terms such as bonus, stock splits and right issues. All these are examples of what we call corporate actions. These are simply actions taken by a company once agreed upon by its board of directors andthen authorized by its shareholders.All such actions have announcement date, ex-date, and record date.
Let’s have a quick look at what these corporate actions mean which will help us understand their impact on the company’s share prices.
A bonus issue is a stock dividend. A company allots these shares for rewarding its shareholders. Issue dout of the company’s reserves,bonus shares are free and the shareholders receive them against the shares currently held.Allotments are typically made in a fixed ratio e.g., 1:1, 2:1, 3:1 etc.
A 2:1 bonus ratio means the existing shareholders (as on the record date) will get 2 additional shares for every 1 share held at zero cost. A shareholder holding 100 shares will get additional 200 shares free, taking his total number of shares held to 300.
On bonus issue, the number of shares held will increase but the overall value of investment will remain the same. Hence price per share reduces.
Let’s take an illustration
|Bonus Issue||No of shares held before bonus||Share price before Bonus issue||Value of Investment||Number of shares held after Bonus||Share price after Bonus issue||Value of Investment|
Companies generally give away bonus shares to boost participation of retail investors, particularly when a company’s share price has risen quite high making entry of new investors difficult. Bonus issue reduces share price by increasing the number of outstanding shares keeping the aggregate value same, thus making it affordable.
This is another way of increasing retail participation and is a quite common phenomenon in the share market. Here the face value of the stock is split into smaller denomination thereby bringing down the market price proportionally. An illustration will make things clear.
|Split Ratio||Old FV||No of shares held before split||Share Price before split||Investment Value before split||New FV||No of shares held after split||Share Price after the split||Investment value after split|
Due to a stock split the number of shares held by the shareholder increases but the investment value remains unchanged just like bonus. Only the face value reduces. Say the face value of a stock is Rs.10, and a 1:1 stock split is announced. Here, the face value will be split in half. But since the market value of shares remains unchanged, and the price per share has to reduce in the same proportion as the face value and the number of shares has to increase inversely. Which means a stock split of 1:1 will reduce share price by half and the number of shares outstanding will double.
A rights issue is for raising fresh capital. The company, instead of going public, approaches its shareholders’ with an option to subscribe to it in proportion of their shareholding. It’s like an IPO for a selected group. A 1:4 rights issue means for every 4 shares held, the shareholder can subscribe to 1 additional share. But unlike bonus it comes at a cost which is lower than the prevalent market price otherwise buying from open market would be more sensible.Shareholders must be convinced of the future prospects of the company. Usually rights issues indicate that the management is confident about future growth prospects.