Bonus shares are the free issue of ordinary shares to existing share- holders. The shares are issued to them without extra cost. The company makes payment of these shares through the profit. As an alternative to paying out cash dividends during a year, a company may choose to pay a scrip dividend. This is essentially a transfer to the shareholder of a number of additional shares without the shareholder having to subscribe additional cash. From the company's point of view, this offer has the advantage of preserving liquidity, for no cash leaves the company. The number of equity shares is increased, but as long as the annual increase is not too large and the retained earnings are invested to yield a satis- factory rate of return, the share price should not fall.
The advantage to the shareholder is that he receives a dividend which he can convert into cash whenever he wishes.
Right Issue
A right issue is an offer of a company's shares to its existing share- holders. It gives the existing shareholders the opportunity to first purchase shares from a new issue of shares. The term of the offer is that each existing shareholder has the right to be alloted a certain number of
shares upon payment of the asking price. This offer does not have to be accepted personally by the existing shareholders. They may sell the right separately from the share or sell the share with the right offer attached.
In times of depressed stock market, equity capital does not appeal either to investors or to the issuers.
A right issue can easily depress the earnings per share at least in the short run. This is because the number of shares immediately increases but not necessarily the earnings.
The success of a rights issue depends upon the size of the issue, the price asked for the shares and the investors' expectation of the earnings that will result from the use of the funds. The earnings that will result depend upon the amount of funds invested as well as the expected rate of return.
Two factors jointly determine the number of new shares a company will need to issue: the amount of new funds the company wishes to raise and the price it considers reasonable to ask for the new shares. The amount of funds to be raised depends upon the earnings that can be obtained from new investments compared with the cost of the funds. The company must ensure that it can earn on the funds that it obtains a rate at least equal to the opportunity cost.