Rights Issue

A company can choose to carry out rights issue when a company wants to raise additional equity funds to finance capital requirement. It is an issue of additional shares subscription exclusively for the company's shareholders. The present shareholders have the right to subscribe to the new shares at a ratio equivalent to their existing shareholdings.

For example, a one-for-two right issue entitles the shareholder to subscribe for one new share for every two ordinary shares he/she presently held. The subscription price for the shares is lower than the market price of the stock at the time the rights are issued.

The shareholders have the choice of taking up the the right issue, selling the entitlements or rights, or allowing the the rights to lapse. If the shareholder chooses to allow the rights to lapse, this will result in a fall in the value of the original shareholding without any compensating gain from the sale of the rights.

Invitation to buy new shares at a subscription price is considered privilege by shareholders. However, theoretically, there is no additional gain to the shareholder as the profit from buying the shares at the lower subscription price is offset by the decline in the stock price after the shares goes ex-rights.

The increase in the number of shares available, especially if the rights issue is large in relation to the paid up capital, will have the likely effect of lowering the stock price. Besides, the increase in share capital will result in lower earnings per share and dividend yield ratio as both are diluted by the new shares. This will also results to depressing the price of the shares.

Nevertheless, in practice, many investors ignore the effect of this new issue. Many believe that the proceeds of the issue will be utilised to finance viable projects which will increase its earnings potential. For this reason, investors regard a rights issue as a cheap way to buy more of the company's shares.

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