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Not Creating Value

Shareholders stand to gain nothing when a company announces the issue of bonus shares

Over the last few days, we’ve all read and heard a lot about how India’s largest company has rewarded its shareholders by giving them bonus shares. It’s wonderful to watch, as we were told, value being created and then being shared with shareholders. This exercise is repeated every time a company issues bonus shares. Since time immemorial, Indian shareholders have always reacted with great joy whenever they have been given bonus shares.

However, no matter how loudly the hosannas are let loose for bonus-givers over the years, it doesn’t change the simple fact of accounting. Bonus shares are no bonus. All the shareholders put together own all the value that is inherent in any company. Doubling the number of shares by transferring some of companies’ reserves into shareholders’ capital does not create any additional value for shareholders.

The whole episode reminds me of how some children prefer buying a brand of chocolate that divides each bar into a greater number of pieces. The kids feel that a slab of chocolate that is divisible into 12 pieces is somehow better than one of the same size which is divisible into just 8 pieces. I guess in a child’s mind, the chocolatemaker has rewarded him with four bonus pieces.

As far as I know, this joy at being given bonus shares has no parallel anywhere else in the world. Perhaps the problem begins with the word itself: ‘bonus’, in every other context, is something extra that one gets. A dictionary defines it as ‘something given or paid over and above what is due’. Another one says it is ‘something extra or additional given freely’. If you accept these definitions, then a mere rearrangement of what is anyway shareholders’ wealth cannot be termed as ‘bonus’ in any fairness. I would say that there is even grounds for market regulator the Securities and Exchange Board of India (SEBI), or the stock exchanges, to ban the use of the word ‘bonus’ for what is merely an accounting book entry.

One interesting thing I’ve heard from old-timers is that the so-called FERA companies used to be aggressive in issuing bonuses because it made their dividends look small. For a certain rupee amount of dividends that a company wants to give out, issuing bonus shares makes the percentage of dividend smaller. While Indian companies would want to be seen as giving high dividends, foreign companies found it politically incorrect to be seen sending out big dividends. Old-timers say that it was not uncommon for such companies to issue bonus shares just before dividends.

Of course, the essential meaninglessness of bonus as an addition to shareholders’ wealth is well-understood by every analyst. Yet, celebrations over a company issuing bonus are rarely muted. One explanation that is often offered is that seeing a bonus as positive merely recognises the reality. It improves the general sentiment about a stock. Shareholders feel that a company is confident of supporting a larger equity base and so on. If this is the case, then the media and analysts owe to their audience to point out the worthlessness of these sentiments instead of encouraging them. Somehow, the whole atmosphere around a high-profile bonus issue is one of a company’s maalik rewarding the faithful. This is a mindset that Indian shareholders need to shed.