How companies decide dividend payouts: Bonus shares or cash, and why it matters for investors

KATHMANDU: Listed companies in Nepal typically begin distributing dividends a few months after the end of each fiscal year, following the approval of audited financial statements and decisions taken by their boards and annual general meetings (AGMs). As the dividend season progresses, most companies have already announced their payouts, opting for bonus shares, cash dividends, or a combination of both.

The variation in dividend structures often raises a key question among investors: how do companies decide what type of dividend to distribute and in what proportion?

Bonus Shares vs Cash Dividends

When a company issues bonus shares, it does not pay cash to shareholders. Instead, it distributes additional shares in proportion to existing holdings, increasing the total number of shares owned by investors. Because the share price is adjusted after bonus distribution, shareholders may not see an immediate financial gain. However, over the long term, if the company’s business expands and profitability improves, the increased shareholding can translate into higher overall returns.

From the company’s perspective, bonus shares do not result in an immediate cash outflow. The retained funds can be used to repay loans, finance new projects, expand existing operations, or invest in new business segments. While this approach can support growth, analysts caution that companies excessively relying on bonus shares merely to keep share prices attractive may face long-term stress. If capital increases are not matched by proportional growth in business and profits, maintaining dividend rates in future years becomes increasingly difficult.

Capital Requirements Drive Dividend Choices

Companies also prioritize bonus shares when they aim to increase paid-up capital. A clear example can be seen in Nepal’s life insurance sector. Until last year, most life insurance companies emphasized bonus shares to meet regulatory capital requirements.

Following the Insurance Authority’s directive mandating a minimum paid-up capital of Rs 500 million, insurers relied heavily on bonus shares issued from retained earnings to reach the threshold. Now that most life insurance companies have met the requirement, their dividend strategies have begun shifting toward higher cash dividends.

Why Some Companies Prefer Cash Dividends

Cash dividends provide shareholders with direct and immediate income, without increasing the number of shares held. Companies with limited expansion plans, minimal debt obligations, or fewer new investment opportunities tend to prioritize cash payouts.

Institutions with foreign investors also often favor cash dividends. This allows foreign shareholders to repatriate profits more easily. Dividend payments in cash involve fewer procedural hurdles compared to selling bonus shares, which requires finding buyers and obtaining regulatory approvals to remit sale proceeds abroad.

Investor Preferences in Nepal

In Nepal’s stock market, most retail investors show a strong preference for bonus shares, driven by the belief that a higher number of shares will generate greater long-term returns as market prices rise. However, there are notable exceptions.

Unilever Nepal, currently the most expensive stock on the market with a share price of around Rs 47,000 per share, has consistently distributed only cash dividends for years. Despite the absence of bonus shares, the company’s strong fundamentals and steady earnings have sustained investor confidence and high valuations.

No Obligation to Pay Dividends Every Year

Regulators emphasize that companies are not legally required to distribute dividends every year. Firms whose reserves weaken due to regular payouts may opt to suspend dividends for certain periods to rebuild retained earnings. This approach, while unpopular with short-term investors, can strengthen companies over the long term.

Nepal’s market also includes companies that have been listed for nearly two decades yet have managed to distribute dividends only once, reflecting weak financial positions and limited growth capacity. Market analysts broadly agree that such companies offer limited long-term value.

What Investors Should Watch

Experts advise investors to look beyond headline dividend announcements and assess profit growth, capital expansion, reserve strength, and business scalability. A balanced dividend policy—combining bonus shares and cash dividends—often reflects healthier financial management, providing shareholders with both immediate income and long-term growth potential.

As dividend announcements continue, analysts urge investors to evaluate not just how much dividend is being offered, but why a company has chosen that structure, and whether it aligns with sustainable growth prospects.