Difference Between Right Shares and Bonus Shares

Key Difference – Right Shares vs Bonus Shares
 

Right shares and bonus shares are two types of shares issued to the existing shareholders of the company. A rights issue and a bonus issue results in an increase in the number of shares, thus reducing the price per share. The key difference between right shares and bonus shares is that while right shares are offered at a discounted price for existing shareholders in a new share issue, bonus shares are offered without a consideration (free of charge) to compensate for nonpayment of dividends.

CONTENTS
1. Overview and Key Difference
2. What are Right Shares
3. What are Bonus Shares
4. Side by Side Comparison – Right Shares vs Bonus Shares
5. Summary

What are Right Shares

Rights Shares are shares issued through a rights issue, where the company offers existing shareholders to sell new shares in the company before offering them to the general public. Such rights of the shareholders – to be offered the shares prior to the general public – are called ‘preemptive rights’. Rights shares are offered at a discounted price to the prevailing market price to provide an incentive for shareholders to subscribe for the shares.

E.g. Company Q decides to issue new shares in order to raise new capital of $20m by issuing 10m shares in a 2:2 basis. This means that for every 10 shares held, the investor receives 2 new shares.

When new shares are offered, the shareholders have the following three options.

Figure 1: Options for shareholders when presented with the option to subscribe for Rights Issue

Continuing from the same example, assume that the market price of the existing shares (shares held prior to the rights issue) is $4.5 per share. The discounted price at which new shares will be issued is $3. The investor has 1000 shares

• If the investor takes up the rights in full,

Value of the existing shares (1000* $4.5)                                        $4,500

Value of the new shares (200* 3)                                                       $600

Value of total shares (1,200 shares)                                                   $5,100

Value per share following the rights issue ($5,100/1,200)           $4.25 per share

The value per share following the rights issue is referred to as the ‘theoretical ex-rights price’ and its calculation is governed by IAS 33 -‘Earnings per Share’.

The advantage here is that the investor can subscribe for new shares at a lower price. If 200 shares are purchased from the stock market, the shareholder has to incur a cost of $900 (200* $4.5). $300 can be saved by purchasing the shares through the rights issue. Following the rights issue, the share price will fall from $4.5 to $4.25 per share since the outstanding number of shares increase. However, this reduction is offset by the saving made through the opportunity to purchase shares at a discounted price.

• If the investor ignores the rights,

The investor may not be willing to invest further in the company or not have funds to subscribe for the rights shares. If the rights shares are ignored then the shareholding will be diluted due to the rise in the number of shares.

• If the investor sells the rights to other investors

In some cases, rights are not transferable. These are known as ‘non-renounceable rights’. But in most cases, investors can decide whether you want to take up the option to buy the shares or sell the rights to other investors. Rights that can be traded are called ‘renounceable rights’, and after they have been traded, the rights are known as ‘nil-paid rights’.

What are Bonus Shares?

Bonus shares are also referred to as ‘scrip shares’ and are distributed through a bonus issue. These shares are issued to the existing shareholders free of charge according to the proportion of their shareholding.

E.g. For every 4 shares held, the investors will be entitled to receive 1 Bonus Share

Bonus Shares are issued as an alternative to dividend payments. For instance, if the company make a net loss in a financial year, there will be no funds available to pay dividends. This may lead to dissatisfaction among shareholders; thus, to compensate for the inability to pay dividends, bonus shares may be offered. Shareholders can sell the bonus shares to meet their income needs.

Issuing bonus shares is an attractive option for companies facing short-term liquidity issues. However, this is an indirect solution for cash limitations since bonus shares do not generate cash for the company, it only prevents the need to incur outflow of money in the form of dividends.

Further, as bonus shares increase the issued share capital of the company without any cash consideration, it could result in a decline in the dividends per share in the future which may not be interpreted rationally by all investors.

What is the difference between Right Shares and Bonus Shares?

Summary – Rights Shares vs Bonus Shares

Companies consider the issue of rights shares and bonus shares when there is a need for funds for future projects or current cash deficits. Both rights shares and bonus shares increase the number of outstanding shares and reduce the price per share. The main difference between rights shares and bonus shares is that while rights shares are offered at a discount to market price, bonus shares are issued without consideration.

Reference:
1. McClure, Ben. “Understanding Rights Issues.” Investopedia. N.p., 29 Dec. 2015. Web. 01 Mar. 2017.
2.”Theoretical Ex Rights Price.” Theoretical Ex-Rights Price |Formula | Calculation | Example. N.p., n.d. Web. 01 Mar. 2017.
3.Pete. “EPS: Rights issues, Options and Warrants | IAS 33 Earnings per Share.” Chartered Education. N.p., 05 Sept. 2015. Web. 01 Mar. 2017.
4.Staff, Investopedia. “Bonus Issue.” Investopedia. N.p., 17 June 2004. Web. 01 Mar. 2017.
5.”Advantages and Disadvantages of Bonus Shares.” EFinanceManagement. N.p., 13 Jan. 2017. Web. 02 Mar. 2017.

Related posts:

Difference Between Shares and Stocks Difference Between Accredited Investor and Qualified Purchaser Difference Between Recourse and Non-Recourse Debt Difference Between Yield and Coupon Difference Between Nifty and Sensex