I and a few hundred among the 18,000-plus Bank of Valletta shareholders attended the recent annual general meeting. For small shareholders, one of the benefits of attending such meetings is that they get the opportunity to ask questions directly to board members or top management. In BOV’s case, most of these questions revolved around these issues: Are bonus shares really a bonus? Why do bonus shares seem to lead to a lower share price?

Board members have a duty to explain decisions to shareholders- Robert Suban

I can confirm that these issues are real concerns shared by most shareholders and which they often misunderstand.

The best way to explain the effects of a bonus share issue is to illustrate it with an example. Let us take a company which currently has 900 shares in total and decides to issue and allocate one bonus share for every nine held. In this case, the company will issue an additional 100 shares and the new total will be 1,000 shares. Let’s say that Mr X had 90 shares in the company before the share issue meaning that he had 10 per cent of the company’s total shares. After the bonus share allocation he will now have an additional 10 shares for a total of 100 shares which will still represent 10 per cent of the company’s total shares.

This means that Mr X will still hold the same proportion of the outstanding shares as before the allocation and the extra shares do not represent any extra allocation. Overall, the value and size of the company has remained the same. However, most shareholders wrongly think that selling the extra allocated shares will represent an extra profit. It is clearly not the case because if they sell the newly allocated shares they will just be reducing the proportion that they hold in the company.

This brings me to the second issue: why does it seem that the allocation of bonus shares issues leads to a lower share price? As explained, the allocation of extra shares means that each share now represents a lower percentage in the share capital of the company and the share price is simply adjusted for that fact. For example, on January 15, when the latest BOV bonus issue of one extra share for nine held became effective, you should have noticed that when the Malta Stock Exchange market opened for trading, the share price went automatically down by 11.11 per cent compared to the previous day’s closing price even if no trades are effected.

This is what has happened in the previous years when such bonus issues have become effective. Given that since 2002, BOV has allocated seven bonus issues (eight, if we take into account the one that will take place in January) a shareholder who had one share in 2002 would now have 5.84666 shares at the end of 2012 and 6.49629 after January 18.

Contrary to the belief of most BOV shareholders present at the AGM, if we factor in all those bonus share issues and readjust the 2002 share price, they would realise that the current share price has increased and has almost doubled. Indeed, even if we use one of the highest share prices achieved in 2002 (Lm3.10 on November 5, 2002, following the announcement of BOV’s year-end results) and readjust in euros (€1 = Lm 0.4293) and using the ratio above we get a share price of €1.23507 in 2002 compared to €2.4 on December 21, 2012.

What about dividends? The same reasoning applies here. Again, contrary to shareholder belief, BOV’s dividend has been increasing since 2002 from 6.37c per share per year to this year’s total of 19c per share. There has only been one year (2007) when the dividend was higher (19.36c per share). It is normal that the nominal amount of the dividend decreases given the increase in the total number of shares but this does not mean that the dividend has decreased. One realises this when taking into account the bonus share issues and adjust the dividend paid accordingly.

If we can readjust the dividend and share price for bonus issues, what is the rationale of bonus share issues? One of the reasons put forward is the increased liquidity. Indeed, if each shareholder has a larger number of shares, this means that supply has increased and it is therefore easier to find shares. Furthermore, the relative decrease in the price of the share makes them look more affordable. Although there is no difference between buying 10 shares at €1 each, rather than one share at €10 each, the human psychology is such that investors will think that there is more value in the former rather than in the latter transaction.

Finally, an increase of 1c in the share price will not have the same effect in percentage terms. If the share price is €1, a 1c increase in the price will translate into a one per cent increase in the share price, whereas an increase of 1c when the share price is €2 will only translate into a 0.5 per cent increase in the share price. Therefore, the lower the share price the higher the fluctuations of the price in percentage terms for similar changes in nominal amounts. Here again, psychology tells us that investors do not reason in percentage terms but in nominal terms.

We expect board members to take good decisions when managing a company, especially when they affect shareholders such as dividend payouts. In the case of listed companies, board members also have a duty to explain these decisions to the shareholders and ensuring that they understand them correctly. This should be a priority if we want shareholders to support those decisions.

Robert Suban is a full-time academic within the Department of Banking and Finance at the University of Malta.