Why Is SEBI Concerned About The Misuse Of Bonus Shares?

The Securities and Exchange Board of India (SEBI) is reported to be looking into the use of bonus issues by companies to influence stock prices.

Recently, Nykaa and EaseMyTrip rewarded their investors with bonus shares.

However, there have been concerns voiced by several analysts and investors that these might have been measures to reduce a sharp decline in stock prices.

Why Do Companies Issue Bonus Shares?

Conventional literature suggests that a company issues bonus shares to “reward” its shareholders.

However, unlike a dividend payment or a buyback, a bonus issue does not really add any immediate value for the investor.

For instance, if you own a stock worth Rs 600, and the company issues a 5:1 bonus you receive five additional shares for each share you own. Effectively, from the investors’ perspective, one share becomes six shares worth Rs 100 each.

From the company’s perspective, it only needs to make accounting changes to its balance sheets’ “reserves” sections. Reserves are converted to share capital, and no outgo or inflow of cash happens during the issue of bonus shares.

Nevertheless, the stock witnesses increased liquidity in the market due to lower stock prices. A lower stock price can make the stock more affordable for smaller investors, increasing investor interest in the stock.

A bonus issue is similar to a stock split, except that a stock split doesn’t convert reserves to share capital and has different tax implications. These tax implications have been one of the main points of contention between Nykaa’s investors and management.

Why Did Nykaa’s Bonus Issue Land It In Controversy?

Publicly listed new-age companies have been having a rough time in the markets for the last several months.

Apart from the usual concerns about a recession, lack of profitability, a dry-up in funding, and other issues, these stocks have seen downward momentum as pre-IPO, promoters and early investors sell off their shares after the lock-in period.

Stocks like Zomato, Paytm, and PB Fintech saw some significant declines in their stock prices after the lock-in ended. Zomato slipped nearly 30 per cent within a couple of days.

Nykaa likely wanted to prevent such a dramatic sell-off in its stocks and declared a bonus issue for the same. When a bonus issue is declared, the price adjusts immediately.

At the same time, the excitement of a bonus issue might propel the stock price upwards along with increased demand due to the share’s lower price.

As a result, investors might become cautious about selling the stock. Nykaa’s bonus issue overlapped with the end of its IPO lock-in, helping the company reduce selling pressure on the stock.

Rather, the stock shot 19 per cent on the day the lock-in ended —something that would have been considered impossible looking at the performance of other new-age companies.

However, apart from the timing, there are tax implications for retail investors as well. Unlike a stock split, a bonus issue causes the bonus shares to be valued at nil cost for taxation purposes.

For investors who had bought during the IPO but wanted to get out, the short-term gains from bonus shares could have a higher tax implication.

EaseMyTrip declared a bonus of 3:1 and a split of 1:2 for its shares. As highlighted earlier, neither a stock split nor a bonus issue adds any immediate value from an investor’s perspective.

Yet, EaseMyTrip’s stock jumped up by 40 per cent. According to reports, the dramatic increase in the stock price has caught the regulator’s attention.

A report by Moneycontrol highlighted that some promoters collude with stock operators to rig up the stock price during the period between the record date and the credit date.

Usually, investors are reluctant to sell during this period, while others even buy in as the rally continues.

Ultimately, the operators take advantage of the reluctance of investors to sell between the record and credit date and end up with a decent profit.

Currently, SEBI does not specify the specific date by which bonus shares should be credited into the account.

Further, bonus shares are sometimes marketed as a free gift for newbie retail investors.

Several shady companies have issued multiple rounds of bonus shares within the same year, along with strong PR campaigns to attract investors for pump-and-dump operations.

In order to prevent companies and operators from using loopholes, it is reported that SEBI is looking to curb these activities by implementing a specific date by which shares would be credited into accounts.

This piece was earlier published here.