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I've spent a good amount of time wracking my brain about how a bonus issue actually benefits the stock holders.

For example in a 1:1 bonus issue, the price of a share corrects to half of the pre-issue price eventually leaving the shareholder with the same worth he had prior to the issue. Also accounting-wise, what I've read is that the company pays for the bonus shares out of its cash reserves, thereby increasing its share capital by the same amount.

But if the stock price corrects itself to the pre bonus value, so will the company's share capital become the same it was before the bonus, the only difference being that there's now a hole in the cash reserves.

So isn't the company just losing money from its reserves while the share capital actually remains the same? What's the point of a bonus issue? What advantage does it have over a stock split? Sorry for bombarding you with questions but I'm new to all of this.

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In the past there were slight differences in the way this was attributed in company accounts and tax law.

As a shareholder/trader, there is no practical difference. You are being diluted; your cost base is adjusted by that ratio, and the market typically reacts accordingly.

Source: Norgate Data - we have tracked over 20K stock splits, almost 15K bonus issues, and almost 10K reverse splits since 1950 over major-exchange-listed, OTC and delisted stocks.

Disclosure: Norgate Data is a data vendor.

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But if the stock price corrects itself to the pre bonus value, so will the company's share capital become the same it was before the bonus, the only difference being that there's now a hole in the cash reserves.

This is incorrect. Say there are 10 shares worth 10 ea. The total Shareholder's capital is 100. This [along with some other items] is classified as Tier 1 capital. Say after few years, the company has been making profit and has profit of 1000. This is classified as Retained Earnings. This is still an Asset Liability; but not same as Tier 1 capital. Say the share price is x. This has no relevance. Total Asset Liability for simplicity is 100 [shareholders capital]+1000 [Retained earnings] = 1100

When a Bonus is issued; say 1:1. The number of shares now become 10. The company moves 100 from Retained Earnings to Shareholder's capital. So total Shareholder capital becomes 200; the retained earnings become 1000-100 = 900. Total Asset Liability is still 200+900 = 1100. The share price would move to x/2.

In Stock Split, the 10 shares of value 10 are split into 20 shares of value 5. So the total Shareholder capital is still 100 and going by above, with retained earnings of 1000; total Asset Liability = 1100. The share price would move to x/2

What's the point of a bonus issue? What advantage does it have over a stock split?

The shareholder capital has special significance from regulation [more so in case of Financial Institutions] as well as general health of a company. A large shareholder capital is always desired as these funds can never be called for ... unlike a debt / loan / bond / payable that companies issue and any untimely recalls can create cash flow issues. However Shareholder capital is due only when the company is wound down.

However for blue chip companies, this often doesn't matter to large extent. It is more of preference. Certain jurisdictions do offer different tax treatments and going one way over other helps.

  • Ah, I see. My understanding of share capital was flawed. I thought secondary transactions of shares had a bearing on the share capital, like the market cap. However, I still don't understand how the shareholders benefit from a bonus if they're just getting double number of stocks they have at half the price. – the das Jun 21 '18 at 9:32
  • one quibble - the things you are calling assets are really liabilities. – mhoran_psprep Jun 21 '18 at 10:05
  • @mhoran_psprep Agreed. Let me redo. – Dheer Jun 21 '18 at 12:01
  • @thedas Generally there is no difference [benefit] to the shareholder. There is small technicality; Share Holder can't demand "Share Holder Capital" unless there is liquidation. They can put pressure on Company Management to return the "Retained Earnings" as form of dividends. – Dheer Jun 21 '18 at 12:06
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    Retained Earnings is neither an asset nor a liability. It is a "capital" account, sometimes called an "equity" account. See, for example, double-entry-bookkeeping.com/retained-earnings/… – Jay Jun 21 '18 at 22:00

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