What is Rights issue ?

Rights issue is a method used by companies to raise funds by issuing additional stocks to the existing share holders of the company. Share holders may or may not exercise their right of acquiring new shares issued by the company. Companies fix up a price for rights issue, usually less than the market price to make sure entire issue will be subscribed. The share holders can apply for more number of shares than they are entitled to. If some of the share holders don’t exercise their right the shareholders who have applied for additional shares are allotted the same.

It’s important for a shareholder to know the reason behind the rights issue i.e. whether the company is raising funds to acquire another company or to expand the existing business or to meet the obligations of the existing business.

Usually the share price comes down proportionately. This is because the company’s equity base goes up with the additional shares and hence the EPS (Earnings Per Share, Total Net Profit / No of shares outstanding; As the denominator increases keeping numerator at the same value the ratio comes down) comes down. Considering the same market conditions, to maintain the same P/E ratio before and after the issue, price comes down.
If the company is going to acquire another company or to expand the existing business which would bring bright future for the company and yield returns in short term the price would be more than the proportionate value. But if the company is struggling to meet the obligations of the existing business and not able to raise funds in the debt market at lower interest rate and has chosen the rights issue to raise funds then the price comes down less than the proportionate value.

October 12, 2008 | Filed Under Stocks

Comments

3 Responses to “What is Rights issue ?”

Saurabh on July 24th, 2009 5:58 am

I guess the price should not come down as it will be a loss for those investors who are not subscribing it.

Please clarify.
Satyam on July 25th, 2009 8:16 am

Saurabh,

The price does get reduced. The reasons I explained in the post. I will write one more post with an example of calculations.

Investors are given choice to either exercise the rights or sell the rights partly or fully.
Saurabh on July 27th, 2009 5:47 am

Satyam,

Thanks a lot. I read your latest example on right issue. It was very informative and made many things clear. I never realized that i am losing by not applying to right issue.

If possible can you write a article on FCCB, ADS, ADR , their use to company etc.

Thanks,
Saurabh