Bonus shares are the additional shares offered by a firm to its existing shareholders as a “bonus”. This is done when the company is not in a position to pay dividends to its shareholders despite earning decent profits for that particular quarter. Allotments are typically made in a fixed ratio e.g. 1:1, 2:1, 3:1, etc.

A 2:1 bonus ratio means the existing shareholders (as on the record date) will get 2 additional shares for every 1 share held at zero cost. This will make the total number of shares held to 3. A shareholder holding 100 shares will get additional 200 shares free, taking his total number of shares held to 300.

On bonus issue, the number of shares held will increase but the overall value of an investment will remain the same. Hence the price per share reduces.

Let’s take an illustration:

Companies generally give away bonus shares to boost the participation of retail investors, particularly when a company’s share price has risen quite high making entry of new investors difficult. Bonus issue reduces share price by increasing the number of outstanding shares keeping the aggregate value the same, thus making it affordable.