Difference Between Bonus Shares & Rights Issue: Understanding Corporate Actions

Confused about bonus shares and rights issues? This comprehensive article explains the key differences between these corporate actions. Discover how companies use these strategies to reward shareholders and raise capital.

In the realm of corporate finance, companies often use various methods to reward shareholders and raise additional capital. Two common approaches are bonus shares and rights issues. While both have a significant impact on a company’s equity and its shareholders, they differ in their purpose and execution. In this article, we will explore the Difference Between Bonus Shares & Rights Issue and shed light on how these actions affect shareholders.

Understanding Bonus Shares

1. Definition of Bonus Shares

Bonus shares, also known as scrip dividends or capitalization issues, are additional shares issued to existing shareholders by a company. These shares are distributed to shareholders in proportion to their existing holdings, increasing the total number of outstanding shares without changing the company’s overall market capitalization.

2. Purpose of Bonus Shares

The primary purpose of issuing bonus shares is to reward existing shareholders without affecting the company’s cash reserves. By capitalizing a portion of the company’s retained earnings or reserves, the company converts them into equity, allowing shareholders to benefit from the increase in shareholding at no cost.

3. Characteristics of Bonus Shares

• Proportional Distribution: Bonus shares are allotted to existing shareholders in proportion to their current shareholdings. For example, if a shareholder holds 100 shares and the company issues a 1-for-5 bonus, the shareholder will receive 20 additional shares.
• No Cash Outflow: As bonus shares are issued by capitalizing retained earnings, there is no cash outflow from the company.
• Lower Market Price: After the bonus issue, the market price of each share is expected to decrease proportionally, maintaining the overall market capitalization.

Understanding Rights Issue

4. Definition of Rights Issue

A rights issue is a method used by companies to raise additional capital from existing shareholders by offering them the right to purchase new shares at a discounted price. These new shares are typically issued at a price lower than the current market price, encouraging shareholders to subscribe to the offer.

5. Purpose of Rights Issue

The primary purpose of a rights issue is to raise capital to fund expansion projects, reduce debt, or strengthen the company’s financial position. By offering discounted shares to existing shareholders, companies incentivize them to participate in the capital-raising process.

6. Characteristics of Rights Issue

• Discounted Price: The new shares offered in a rights issue are priced at a discount to the current market price, making the offer attractive to existing shareholders.
• Cash Inflow: When shareholders subscribe to the rights issue, they pay cash to the company for the new shares, leading to an inflow of capital for the company.
• Non-Proportional Allotment: While bonus shares are allotted in proportion to existing holdings, rights issue allows shareholders to purchase additional shares based on the number of rights entitlements they hold.

Key Differences Between Bonus Shares & Rights Issue

7. Purpose

• Bonus Shares: Reward existing shareholders without utilizing cash reserves.
• Rights Issue: Raise additional capital to fund company projects or reduce debt.

8. Source of Shares

• Bonus Shares: Issued by capitalizing the company’s retained earnings or reserves.
• Rights Issue: New shares are created and offered at a discounted price to existing shareholders.

9. Cash Flow Impact

• Bonus Shares: No cash outflow as shares are issued using internal reserves.
• Rights Issue: Cash inflow to the company as shareholders pay for the new shares.

10. Shareholder Involvement

• Bonus Shares: All shareholders receive additional shares in proportion to their holdings.
• Rights Issue: Shareholders have the option to subscribe to the new shares based on their rights entitlements.