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Rights Issue

Rights Issue

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Published by Srinivas Reddy

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Categories:Types, Research
Published by: Srinivas Reddy on Jun 28, 2010
Copyright:Attribution Non-commercial

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01/11/2013

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Rights IssueLearning objectiveAfter completing this chapter you will be able to answer tothese questions:
What is rights issue?What are the reasons for such rights/Under what circumstances the company shall decide onrights issue?What are the hazards in case of rights issue?How the company should approach to price the rights/shares conversion ratio?What are the strategic points worth considering whileformulating the company’s strategy on rights?
Chapter Content
1.
 
Definition2.
 
Features3.
 
Conditions to be satisfied by the firm4.
 
Impact on price of existing equity5.
 
Impact on shareholders’ wealth6.
 
Pricing of rights
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What is Rights Issue?
An existing company which has already gone for an IPO has a base of its own stockholders. If the company has been doing quite well and itsstockholders are happy with its performance, it can approach theexisting equity shareholders for further finance in case of necessity likeexpansion and launching new projects. Who could be a better choicethan its satisfied owners? The company has to make least efforts tosell its equity in terms of marketing. It has very little to prove beforeits own shareholders who are with them for quite some time. Both theissue cost and time cost of the issue would be less than the cost hadthe company gone for another public issue. And offering shares toexisting shareholders is called Rights Issue.The nomenclature Rights is because under the company law in case of all the subsequent public issues after the IPO, a company has to offerfirst to its existing stockholders. Thus this is a right to the stockholdersgiven by law. That is why such an issue is called a Rights Issue. Rightsare not an Indian typicality only. Almost in every country similar lawexists. However, the stockholders themselves can relinquish thisprovision by a passing a resolution that effect in a general meeting of the company. In that case the company would not be allowed to go fora Rights Issue. The shareholders can also relinquish their rights evenby part.
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What is ‘Rights’?
Popularly, shares issued through a Rights Issue are called rightsshares. In fact, there is a difference between rights and what isreferred to as rights shares.A shareholder is entitled to rights equal to the number of equity shareshe is holding. That is the number of rights is exactly equal to thenumber of shares held by the investor. These rights are converted intoequity shares at the conversion ration as decided by the managementof the company. Rights are negotiable and tradable like shares. Thisindicates that the rights in the market has a price. Although it isdifficult to measure the possible market price of a right, on the basis of the assumption that a shareholder’s wealth position can hardly beaffected by a Rights Issue, we may calculate some indicative price of rights.The assumption of no change in shareholders’ wealth position is quiterational. When the shares are offered only to the existingshareholders, the pre-issue and post-issue holders remain the same.That is the demand side of the rights also remain the same, while thesupply side has gone up since the stockholders are in possession of more shares from the same company. This must logically bring theshare price down in the market. The erosion in price should be exactlyto the extent of the so called extra benefit afforded to the existingstockholders. Thus the wealth position of the stockholders maintains astatus quo. This also implies that if one existing stockholder does notsubscribe to the rights issue, his wealth position is bound to erodesince he will be left with the same holding, but at a lower market price.
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