Define Capital Bonus:

"A capital bonus, also known as a bonus share issue or bonus issue, is a corporate action in which a company distributes additional shares to its existing shareholders at no cost."

Explain Capital Bonus:

Introduction:

A capital bonus, also known as a bonus share issue or bonus issue, is a corporate action in which a company distributes additional shares to its existing shareholders at no cost. These bonus shares are issued in proportion to the shareholders' current holdings, and the company's total outstanding shares increase. The primary purpose of a capital bonus is to reward shareholders and enhance shareholder value without affecting the company's financial position.

In this article, we explore the concept of a capital bonus, its mechanics, and its implications for shareholders and the company.

Mechanics of a Capital Bonus:

1. Proportional Distribution: When a company announces a capital bonus, it sets a bonus ratio that determines the number of bonus shares to be issued for each share held by a shareholder. For example, if the bonus ratio is 1:1, each shareholder will receive one additional bonus share for each share they already own.

2. Source of Bonus Shares: Bonus shares are typically issued from the company's reserves or retained earnings. These reserves are accumulated profits that the company has not distributed to shareholders as dividends.

3. No Cash Outflow: Unlike cash dividends, a capital bonus does not result in any cash outflow from the company. Instead, the company transfers a portion of its accumulated profits to the share capital account and allocates the new bonus shares to eligible shareholders.

Implications for Shareholders:

1. Increased Shareholding: A capital bonus results in an increase in the number of shares held by each shareholder. While the proportionate ownership in the company remains the same, shareholders benefit from a higher number of shares.

2. No Change in Total Value: A capital bonus does not change the total value of a shareholder's investment in the company. Since the value of the company is spread over a larger number of shares, the market price of each share is adjusted proportionately, keeping the total value unchanged.

3. Liquidity: Shareholders may experience an increase in the liquidity of their investment after a capital bonus. With more shares available for trading in the market, the bid-ask spread tends to narrow, facilitating easier buying and selling of shares.

4. Positive Sentiment: A capital bonus is often seen as a positive signal by investors and the market. It reflects the company's strong financial position and management's confidence in the company's future prospects.

Implications for the Company:

1. Retained Earnings Utilization: By issuing bonus shares from retained earnings, the company effectively converts accumulated profits into share capital. This helps utilize excess cash reserves without distributing cash dividends.

2. Improved Capital Structure: A capital bonus can enhance the company's capital structure by increasing the share capital without raising additional capital through external sources.

3. Attracting New Investors: A capital bonus may attract new investors who perceive the increased liquidity and positive sentiment as favorable factors for investing in the company.

Conclusion:

A capital bonus is a corporate action that rewards shareholders by distributing bonus shares in proportion to their existing holdings. It is a means for companies to utilize their accumulated profits without incurring cash outflow and can enhance the liquidity and attractiveness of the company's shares. For shareholders, a capital bonus results in increased shareholding without changing the total value of their investment.

As a mechanism to distribute rewards to shareholders and demonstrate confidence in the company's performance, a capital bonus serves as a strategic tool for companies aiming to optimize their capital structure and enhance shareholder value.