Bonus shares and stock splits are corporate actions used by companies to restructure their share capital without bringing in new funds. These actions increase the number of shares held by investors while proportionately adjusting the market price, so the overall investment value remains largely unchanged in the short term. Bonus shares are issued by capitalising accumulated reserves, whereas stock splits reduce the face value of shares. Both measures improve share affordability, enhance market liquidity, and encourage wider investor participation without affecting the company’s underlying business operations or ownership structure.

From a financial and legal perspective, bonus issues and stock splits mainly impact per-share indicators such as earnings per share and book value per share, which decline mechanically due to the increased share count. They are governed by specific provisions of corporate law and, in the case of listed companies, securities regulations that ensure transparency and investor protection. Their real significance lies in improving market efficiency and accessibility, while long-term value creation continues to depend on the company’s financial performance, governance quality, and growth strategy.

In this article, CA Manish Mishra talks about Financial Impact of Bonus Shares and Stock Splits.

Conceptual foundation: Why companies issue bonus shares and stock splits

Companies resort to bonus issues and stock splits primarily to align their share price with market expectations, improve trading liquidity, and broaden shareholder participation. Over time, as companies grow and accumulate reserves, share prices may rise significantly, making them less accessible to retail investors. A bonus issue or split reduces the per-share price and increases the number of shares, thereby improving market participation without affecting the company’s operational fundamentals. These actions also serve signaling functions bonus shares may convey confidence in long-term sustainability, while splits often indicate management’s intention to enhance market liquidity.

Bonus shares: Economic and financial implications

A bonus issue involves issuing additional fully paid equity shares to existing shareholders without any consideration, by capitalizing accumulated reserves. From a financial perspective, this is not a distribution of profit but a reclassification within equity. Reserves decrease, paid-up share capital increases, and total shareholders’ funds remain broadly unchanged. Since no cash inflow or outflow occurs, the company’s asset base and earning capacity remain unaffected.

Market prices adjust downward proportionately after a bonus issue. For example, in a 1:1 bonus, the number of shares doubles and the share price typically halves. This price adjustment is mechanical and reflects the same underlying value being distributed over a larger number of shares. Investors do not lose value because the increase in quantity offsets the decrease in price. However, liquidity often improves because more shares are available for trading at a lower price point.

Legal framework governing bonus shares under Indian company law

Bonus issues are governed by Section 63 of the Companies Act, 2013. The law permits companies to issue bonus shares only from specified sources such as free reserves, securities premium, or capital redemption reserve. Reserves created from revaluation of assets are expressly excluded. The rationale behind this restriction is to ensure that bonus issues reflect real accumulated profits and not artificial accounting revaluations.

The Articles of Association must authorize the issue of bonus shares. If such authorization is absent, the Articles must be amended before proceeding. The law also requires that all existing shares must be fully paid before a bonus issue is made, preventing discrimination among shareholders. Importantly, once a bonus issue is approved or announced through proper corporate processes, it cannot be withdrawn arbitrarily, as shareholders and markets rely on such declarations.

Corporate approvals and compliance process for bonus issues

In practice, the bonus issue process begins with a board meeting approving the proposal and determining the ratio. Depending on the company’s structure and Articles, shareholder approval may be required. After approvals, the company must complete allotment, update statutory registers, issue share certificates or demat credits, and make applicable regulatory filings. Listed companies must also comply with stock exchange disclosure norms and corporate action timelines, which are significantly more stringent.

Stock splits: Financial and structural implications

A stock split, also known as sub-division of shares, reduces the face value of each share and increases the number of shares proportionately. Unlike a bonus issue, a split does not involve capitalization of reserves. The paid-up share capital remains the same in aggregate, but it is divided into a larger number of shares with a lower face value.

From an economic perspective, stock splits are designed primarily to enhance liquidity and affordability. A lower post-split share price can reduce entry barriers for retail investors, increase trading volumes, and improve price discovery. As with bonus issues, the total market capitalization generally remains unchanged immediately after the split, subject to market sentiment.

Legal provisions governing stock splits

Stock splits are governed by Section 61 of the Companies Act, 2013, which allows companies to alter their share capital through sub-division or consolidation. As with bonus issues, authorization in the Articles of Association is essential. Corporate approvals must be obtained, and statutory records must be updated to reflect the new capital structure.

Because stock splits affect the face value and number of shares, they require careful coordination with registrars, depositories, and stock exchanges to ensure accurate demat credit and seamless trading continuity. Any mismatch between corporate records and depository data can lead to investor grievances and regulatory scrutiny.

SEBI compliance for listed companies: Disclosure and record date discipline

For listed entities, both bonus issues and stock splits are subject to SEBI’s disclosure and listing regulations. Companies must promptly inform stock exchanges of board decisions, proposed record dates, and execution timelines. The record date is critical as it determines shareholder eligibility. Exchanges also fix the ex-date, from which shares trade at the adjusted price.

Recent regulatory emphasis has been on reducing the gap between approval, record date, and actual credit of shares to investors. This reflects SEBI’s broader objective of enhancing market efficiency and minimizing settlement risks. As a result, companies must now ensure operational readiness before announcing corporate actions.

Impact on per-share financial metrics and accounting treatment

Both bonus issues and stock splits significantly affect per-share financial indicators. Since the number of shares increases, Earnings Per Share (EPS) decreases mechanically, even though total profits remain unchanged. Book value per share also reduces proportionately. Accounting standards require companies to restate historical EPS figures for comparative periods as if the bonus or split had occurred earlier, ensuring meaningful financial analysis.

In a bonus issue, the balance sheet reflects a shift from reserves to share capital, while in a split, the balance sheet total remains the same but with a revised share count and face value. These changes do not affect cash flows or profitability but alter the presentation of equity.

Tax implications for shareholders in India

Tax treatment differs materially between bonus shares and stock splits. Bonus shares generally have a nil cost of acquisition, meaning that when such shares are sold, capital gains are computed on the full sale consideration, subject to holding period classification and applicable tax rates. The holding period typically begins from the date of allotment or credit of the bonus shares.

In the case of stock splits, the original acquisition cost is apportioned across the increased number of shares. The cost per share decreases, but the total cost remains the same. The holding period generally continues from the original acquisition date. Accurate documentation of corporate actions is essential for correct capital gains computation and tax compliance.

Effect on ESOPs, convertibles, pledges, and contractual arrangements

Bonus issues and stock splits also affect equity-linked instruments such as employee stock options, convertible securities, and pledged shares. Adjustment clauses typically require proportionate changes to exercise prices, conversion ratios, and quantities to preserve economic neutrality. Failure to properly adjust these instruments can lead to contractual disputes and regulatory issues, particularly in listed companies where disclosures are closely monitored.

Governance risks and common compliance failures

The most common legal and compliance failures include issuing bonus shares without sufficient eligible reserves, proceeding without proper authorization in the Articles, ignoring partly paid shares, and failing to comply with disclosure or record date requirements. In stock splits, errors often arise from incorrect alteration of capital records, demat mismatches, and inadequate coordination with market infrastructure institutions.

From a governance perspective, companies must ensure transparency, procedural discipline, and investor communication. Poorly executed corporate actions can erode investor trust even if the underlying business remains strong.

Strategic evaluation: Do bonus shares and splits create value?

Bonus shares and stock splits do not create intrinsic value by themselves. They merely restructure how ownership is represented. Long-term value creation depends on profitability, growth prospects, governance quality, and capital allocation efficiency. However, when used strategically and executed compliantly, these corporate actions can improve liquidity, broaden investor base, and enhance market perception.

Conclusion

Bonus shares and stock splits play an important role in reshaping a company’s share structure without changing its underlying business value. Although these actions do not create immediate wealth for shareholders, they influence market perception by improving share affordability, liquidity, and trading participation. They also affect per-share financial indicators such as earnings per share and book value, which adjust mechanically due to an increased number of shares. For investors, these corporate actions often enhance the overall trading experience and accessibility, even though long-term returns continue to depend on the company’s fundamentals and growth prospects.

From a compliance perspective, the effectiveness of bonus issues and stock splits depends heavily on proper legal and procedural execution. Companies must strictly comply with the Companies Act, applicable SEBI regulations for listed entities, accounting standards, and tax provisions. Adequate planning, clear disclosures, and operational preparedness help build investor confidence and maintain market efficiency. Conversely, lapses in compliance or execution can lead to regulatory scrutiny, investor grievances, and reputational harm, undermining the intended benefits of these corporate actions.

Frequently Asked Questions (FAQs)

Q1. Do bonus shares or stock splits increase a shareholder’s wealth?

Ans. No, bonus shares and stock splits do not immediately increase a shareholder’s wealth. They increase the number of shares held, but the market price adjusts proportionately. As a result, the total value of the investment generally remains the same immediately after the corporate action. Any long-term gain depends on the company’s future performance, not the bonus or split itself.

Q2. What is the key legal difference between bonus shares and stock splits?

Ans. The key legal difference lies in their treatment under the Companies Act, 2013. Bonus shares are governed by Section 63, which involves capitalization of reserves into share capital. Stock splits are governed by Section 61, which deals with alteration of share capital through sub-division of shares. Bonus issues affect reserves, while splits only change face value and share count.

Q3. Can a company issue bonus shares even if it is making losses?

Ans. Yes, a company can issue bonus shares even if it is currently incurring losses, provided it has sufficient eligible reserves accumulated from previous profitable years. The law focuses on availability of reserves, not current-year profitability.

Q4. Are shareholder approvals mandatory for bonus issues and stock splits?

Ans. Shareholder approval depends on the Articles of Association and the nature of the action. In many cases, a bonus issue or stock split requires shareholder approval through an ordinary resolution. If the Articles do not authorize the action, they must first be amended with shareholder consent.

Q5. Can a company withdraw a bonus issue after announcing it?

Ans. Once a bonus issue is approved or formally announced following the prescribed corporate process, it cannot be withdrawn arbitrarily. This is because shareholders and the market rely on such announcements, and withdrawal may be treated as a governance failure.

Q6. What happens to the face value of shares in a bonus issue?

Ans. In a bonus issue, the face value of shares does not change. Only the number of shares increases, and reserves are converted into share capital. In contrast, a stock split changes the face value of each share.

Q7. How do bonus shares and stock splits affect EPS (Earnings Per Share)?

Ans. Both bonus shares and stock splits reduce EPS mechanically because the number of shares increases while profits remain the same. This reduction does not reflect a decline in profitability. For proper analysis, EPS figures must be restated for prior periods to ensure comparability.

Q8. What is the tax impact of selling bonus shares in India?

Ans. Bonus shares generally have a nil cost of acquisition for tax purposes. When such shares are sold, capital gains are calculated on the full sale value, subject to holding period rules and applicable tax rates. Proper documentation of allotment dates is essential for correct tax computation.

Q9. How is taxation handled in case of stock splits?

Ans. In a stock split, the original purchase cost of shares is proportionately divided across the increased number of shares. The total cost remains the same, but the cost per share reduces. The holding period usually continues from the original purchase date.

Q10. Do bonus shares or stock splits dilute promoter holding?

Ans. No, these corporate actions do not dilute promoter or public shareholding percentages. All shareholders receive shares in the same ratio, so ownership proportion remains unchanged unless there are other simultaneous transactions.