Comparing Right Issue and Bonus Issue of Ordinary Shares: Pros and Cons
When a company seeks to raise capital, it can choose between a rights issue and a bonus issue. Both methods involve the issuance of new ordinary shares, but they differ significantly in terms of the rights and benefits provided to existing shareholders. Understanding the merits and demerits of each can help investors and company management make informed decisions. This article delves into the specifics of rights issues and bonus issues, highlighting their differences and implications.
What is a Rights Issue?
A rights issue is a method by which a company issues new shares to its existing shareholders at a discounted price. This allows existing shareholders the right to subscribe for new shares proportional to their current holdings, at a price lower than the market value. While this can be beneficial for raising capital, it also poses certain challenges.
Key Benefits of a Rights Issue
Existing Shareholders Get Preferential Access: Shareholders are given the first and often the only opportunity to subscribe to the new shares, which means they get preferential access over the general public, giving them the first chance to maintain their ownership percentage. Lower Cost of Capital: The discounted price at which existing shareholders can purchase the new shares leads to a lower cost of capital compared to a public offering. Signal to the Market: Issuing a rights issue can be interpreted as a bullish sign by the market, as it shows confidence in the company's future prospects.Key Challenges of a Rights Issue
Shareholder Dissatisfaction: Some shareholders might feel that their ownership stake dilutes over time as new shares are issued, leading to potential dissatisfaction. Market Reaction: The company's stock price might drop after announcing a rights issue, as it often reflects a future dilution of earnings per share. Administration Costs: Despite the lower cost of capital, the administrative costs of a rights issue are often high, including legal and regulatory compliance.What is a Bonus Issue?
A bonus issue is a special distribution of additional shares to existing shareholders, with no consideration being paid for these shares. These new shares are typically created without the company raising additional cash. Unlike a rights issue, a bonus issue does not involve any immediate cash expenditure by shareholders.
Key Benefits of a Bonus Issue
No Cash Outlay: Shareholders receive new shares without any immediate financial burden. This can be particularly advantageous when the stock market is not favorable or the company does not have substantial cash reserves. Avoiding Dilution: A bonus issue can help a company avoid diluting the earnings per share (EPS) and keep the current ownership percentage unchanged. Increasing Shareholder Wealth: The additional shares act as a windfall for existing shareholders, potentially leading to wealth value.Key Challenges of a Bonus Issue
No Direct Capital: A bonus issue does not provide the company with immediate capital to invest, which could limit its ability to fund new projects or operations. Email and Communication Costs: Managing and communicating about a bonus issue can be complex, and there are often associated administrative costs with this type of stock issuance. Mixed Reactions: While some shareholders might view a bonus issue positively, others might see it as a sign that the company lacks alternative ways to raise capital.Conclusion
The choice between a rights issue and a bonus issue depends on the specific circumstances of the company and its shareholders. A rights issue provides preferential access to existing shareholders at a discounted price, which can be beneficial for raising capital and maintaining ownership percentages. On the other hand, a bonus issue offers an immediate distribution of additional shares without immediate cash outlay, potentially increasing shareholder wealth but without direct capital gain for the company. Both methods have their merits and drawbacks, and careful consideration should be given to the overall strategic goals and market conditions of the company.