Offers of rights issue and bonus share issue have the same effect on stock but have fundamentally different approaches to doing so. Both of them offer the shareholder a chance to own more shares but at the cost of having their shares valued at a lower price. Here’s how they work:

Right issue:

It is an invitation by a company to the existing shareholders to get their hands on additional shares relative to the original shares they are holding. This offer is issued in terms of proportion i.e. 1 share for every 4. The additional share is sold to the shareholder at a cheap price, usually a discount of the market price then. The discounted price can also act an indication of the lowest price the company expects it to hit.

The idea behind having a rights issue varies from company to company. The main objective is to raise capital from shareholders. The gain in share value or trade in the securities exchange does not provide tangible monies for a company. Rights issues allow them to draw a tangible asset, cash, from the issued shares. Use of this resource depends on the company’s needs, which can be expansion (in the event they cannot borrow money), paying debts or making a quick fix on their balance sheet.

The overall effect of a rights issue is a decrease in the stock price for a shareholder. Here’s how:

Remember, you have a right to partake in buying the discounted stock if you were a shareholder at the close of business on 19^th September 2012. The closing price then was KES 211. That said, the result of the introduction of new shares KES 145 will see the worth of each of your existing shares reduce from KES 211 to KES 206. The perceived loss in share value is however offset by the market’s valuation of the share. By this I mean that the new share cost you KES 145 while the market values it at KES 206. The gain in share’s value of KES 61 helps offset this loss.

Should you opt not to involve yourself in the rights issue, the value of your shares will drop to KES 196 i.e. KES 2,743 (from above) divided by 14 shares. In this case, both the value of your shares and your percentage ownership drop.

Bonus Issue:

Also known as a capitalization issue, it is an offer to the existing shareholders to get their hands on additional shares relative to the original shares they are holding without paying. It is a free issue and is normally given as a proportion, much like in the rights issue.

A bonus issue may be used as an alternative to increasing dividend payout. It has the effect of increasing the number of shares a shareholder has in their possession. The outcome of a bonus issue however, is a greater decrease in share price than in a rights issue. Using the same prices for Standard Chartered Bank example above:

What the numbers mean: While a rights issue can result in a decrease in ownership in the company, a bonus issue maintains the ratio of shares held by each shareholder. The former issue also requires you to pay to keep your ownership constant while the latter is free of charge. This pay however, ensures that your shares maintain a relatively high value. An individual looking to sell their shares would make more if they took part in the rights issue than if they ignored it or received a bonus issue.