Discuss the relative merits of a rights issue of ordinary shares and a bonus issue of ordinary shares

• At shareholder meetings, a company agrees on the number of total shares authorised. This is the maximum number of shares the company can issue; key because it dilutes other shareholders, affects the funding options, impacts the valuation of the firm, talent attraction and retention. Shareholders care about economics and control.• The first key difference between bonus shares and rights shares is that bonus shares is not a source of funding, so it does not increase a company’s cash balance. For rights issues, this actually increases the cash of the company. • Rights issue are an alternative to raising money from the bank or issuing equity in the public markets, both costly alternatives. Rights issues are offered to existing shareholders who wish to increase their stake in the company because they believe the company is going to do well in the future and take advantage of future dividends. If the rights issue is taken up by existing shareholders this also sends a positive signal to the market making it easier to raise financing in the future. Rights issue are offered at a discount, which means at a price lower than the current market value in order to incentivise shareholder to take up the shares• What is the accounting impact of a rights issue?It does not necessarily lead to a dilution of the shares outstanding; depends on the number of shareholders that exercise their right to buy the shares. Both the number of shares and the equity in the firm increases. It affects the assets and equity sections (D: Cash balance; CR: Share capital, Share premium)• Bonus issues is only a book entry and will not lead to a cash inflow. These are a way of rewarding shareholders or employees, if they cannot issue dividends due to cash problems.• They may not want to issue shares if the share price is very high so small investors would not be able to buy into this. So by issuing bonus shares the firm dilutes the share price so it makes it accessible to other investor types. This follows a simple supply and demand theory. The more shares there are in issue the less people want them and so the price falls.• Accounting impact: Increases the number of shares outstanding, which goes into the calculation of the share price, lowering it. Affects only the equity section of the balance sheet (CR: Share capital, D: Share premium)