RIGHTS OF COMMON SHAREHOLDERS

COMMON SHARES

 Common share is also called equity share or

ordinary share or common stock or share.
 Common shareholders are real owner of the
company.
 Common shareholders have residual claim on
income and assets of the firm.
 Rights of common shareholders

Major rights of common shareholders in a company are:

1. Voting right : Right to elect BOD members

2. Preemptive right: First right to buy new shares issued by

the firm.
 Voting right of shareholders

 Right to be a nominee for BOD election.

 Right to vote to elect BOD members.

 Voting Systems

Voting systems to elect BOD members in a firm:

1. Non cumulative voting system

or
Straight voting system
or
Majority voting system

2. Cumulative voting system

 Non cumulative or straight or majority voting system

 
Under this system, number of shares required to elect a desired
number of directors (req.) can be calculated as below:
req. =
Where,
req. = required no of shares
N = total no of shares outstanding entitled to vote.
Cumulative voting system

Under
  this system, number of shares required to elect a desired
number of directors (req.) can be calculated as below:

req. =

Req= required no of shares

des= desired no of directors to elect
= total no directors to be elected
N = total no of shares outstanding entitled to vote.
 Example:
As one of the minority shareholders of M. Company Ltd., Mr. X is
dissatisfied with the current operations of the company. He feels that if
he could gain membership on the company's board of directors, he
could pursue the company to make improvements. The problem is that
current management controls 75 percent of the stock. He controls only
7 percent, and the balance is held by other minority shareholders. There
are a total of 500,000 voting shares. Ten directors will be elected at the
next annual stockholder meeting.
a) If voting is non-cumulative, can Mr. X elect himself as a director?
b) Suppose he is able to persuade all the minority shareholders that he
should be elected. If voting is non-cumulative, can they elect him?
c) If voting is cumulative, can he elect himself as a director?
d) What percent of the minority shares other than his own will he
needs to have voted for him to be certain of election?
e) What is the number of directors the minority shareholders can elect
with certainty?
Solve: Given
Number of shares outstanding (N) =500,000 shares
Shares held by current management = 75%
Shares held by Mr. X = 7%
Share held by other minorities = 100% – 75% – 7% = 18%
Total number of directors to be elected (#) = 10.
Now
Number of shares held by current management
= 75 % of 500000 = 350,000 shares
Number of shares held by Mr. X
= 7% of 500,000 shares = 35,000 shares
Number of shares held by other minority
= 18% of 500,000 = 90,000 shares
 

(a) If voting system is non-cumulative or straight

Number of shares required to elect desired number of directors

(req.)

= = = 250,001 shares

Under non-cumulative voting, 250,001 shares are required to

elect one director with certainty but Mr. X has only 35,000
shares. Therefore, he cannot elect himself to the board of
directors.
 
b. Number of shares held by all minority shareholders
= shares of Mr. X + shares of other minority
= 35,000 + 90,000
= 125,000 shares
No, they cannot elect Mr. X because minority shareholders have only
125,000 shares, while majority shareholders have 375,000 shares and can
elect all directors.

C. If voting is cumulative,
Number of shares required to elect one director
= = shares
Under cumulative voting, 45,456 shares are required to elect one director
with certainty. But Mr. X has only 35,000 shares. Therefore, Mr. X cannot
elect himself as a board of director- even if voting is cumulative.
 
d. Calculation of required percentages of other minority's shares
Additional shares required from other minority to elect himself
= 45,456 – 35,000 = 10,456 shares
Required percentage of other minority's shares
=
= = 0.1162 =11.62%
e. Calculation of desired number of directors can elect by all minority with
certainty.
Req =
des =
=
= 2.75 directors
= 2 Directors
The minority shareholders can elect only 2 directors with certainty.
 Preemptive Right And Right Offering

 Preemptive right is first right of existing shareholders to

purchase new shares issued by a firm at subscription price.

 Right offering is an example of preemptive right.

 Right offering is one of most popular method of raising

capital by selling additional common share to the existing
share holders:
 Preemptive Right And Right Offering

Important dates in right issue process

1. Declaration date (DD)
2. Ex right date (ERD)
3. Date of record (DOR)
4. Expiration date (ED)

Jan 10 Feb 5 Feb 6 Feb 8 Feb28

DD ERD DOR ED

Right on price Ex right price

of stock (Po) of stock (Pe)
 Analysis of Right Offering

Financial manager must analyze following questions before

right offering.
1. How much financing needed under right offering?
2. What should be selling price per share under right offering
(subscription price) ?
3. How many shares must sold to get desired financing?
4. What will be the value of a right?
5. What will be price per share after right offering?
6. What will be the effect of right offering on shareholders
wealth.
7. What will be the effect of right offering on company’s
balance sheet and income statement?
 Preemptive Right And Right Offering
 
Some formulas related with right offering are:

1. Number of new shares =

= XXX shares

2. Number of right required to purchase a share (#)

=
= XXX rights (XXX no of old shares)

Note that, 1 old share = 1 right

 Preemptive Right And Right Offering
 
3. Theoretical value of a right (Vr) = = Rs XXX.

Note: Theoretical value also called formula value

4. Ex-right price per share (Pe)

= Right on price – value of each right
= Po – Vr
Or Pe =
5. One ex-right date and thereafter ……..
Theoretical value of a right (Vr) = = Rs XXX.
 Preemptive Right And Right Offering
Example: Sunrise Tea Company plans to raise additional fund Rs 10
million through rights offerings. Current market price of the
company's stock is Rs 250. It has 200,000 shares outstanding.
Stockholders are offered one new share at a price of Rs 100 each.
Required:
a) How many new shares will have to be sold to raise required
funds?
b) How many rights will be required to purchase a new share?
c) What will be theoretical value of rights?
d) Calculate ex-rights price.
Solve:
Financing needs or funds to be raise = Rs 10 million
Current price per share (Po) = Rs 250.
Existing no of shares outstanding = 200,000 shares.
Subscription price per share (Ps) = Rs 100.
 Preemptive Right And Right Offering
 
Now,
(a) Number of new shares =
=
= 100,000 shares

(b) Number of right required to purchase a share (#)

=
=
= 2 rights
 Preemptive Right And Right Offering
 
Now,
(c) Theoretical value of a right (Vr) =
=
= Rs 50
(d) Ex-right price per share (Pe) = Po – Vr
= 250 – 50
= Rs 200
Alternatively,
Ex-right price per share (Pe) = = = Rs 200
 Effect of Right Offering on shareholders’ wealth

Effect after right offering:

1. When all rights are exercised
2. When all rights are rights are sold
3. When some rights are used (exercised) and some are sold.
4. When all rights are discarded ( expire)
 Effect of Right Offering on shareholders’ wealth

Example:
Suppose you presently own 100 shares of ABC Company.
Current market price per share of the company is Rs 144.
Presently you have Rs 10,600 cash balance. The company
announces right offering under which you need 2 rights to buy
a new share at a subscription price of Rs 120.
Required:
(a) Your current wealth position
(b) Wealth if you exercise all your rights
(c) Wealth if you sell all your rights
(d) Wealth if you exercise 60 right and sell 40 rights
(e) Wealth if all rights are expire (neither sell nor exercise).
 Effect of Right Offering on shareholders’ wealth
 
We have,
Present or old no of shares = 100 shares
Current market price (Po) = Rs 144
Current or old cash balance = Rs 10,600
Subscription price per share (Ps) = Rs 120.
No of rights required to buy one new share (#) = 2 rights
Now,
No of new shares can purchase = = 50 new shares
Theoretical value of a right (Vr) = = = Rs 8
Ex-right price per share (Pe) = Po – Vr = 144 – 8 = Rs 136
 Effect of Right Offering on shareholders’ wealth

(a) Present wealth position:

 Total market value of shares at present ..
(Current no of shares hold x Po) XXX
 Cash balance at present XXX
Total wealth (assets) XXX

Now,

 Total market value of shares at present ..

(100 x 144) 14,400
 Cash balance at present 10,600
Total wealth (assets) 25,000
 Effect of right offering when all rights are exercised
 No of shares increase (old shares + additional shares)
 Market price per share decreases to ex-right price (Pe)
 Cash balance reduce by purchase value of new shares i.e. by (new
shares X Ps.)

 Total market value of shares after exercise all rights ..

(Old share + New shares) X Pe XXX
 New cash balance [ Old balance – (new shares X Ps)] XXX
Total wealth (assets) XXX

Thus,

 Total market value of shares after exercise all rights ..

(100+50) X 136 = 150 X 136…………………………… 20,400
 New cash balance [ 10,600 – (50 X 120)] 4,600
Total wealth (assets) 25,000
 2. Effect of right offering when all rights are sold
 No of shares not affected
 Market price per share decreases to ex-right price (Pe)
 Cash balance increase by cash income from sale of rights i.e. by
(total no of rights x Vr).

 Total market value of shares after sell all rights ..

(Old share X Pe ) XXX
 New cash balance [ Old balance + cash from sale of rights] XXX
Total wealth (assets) XXX

Thus,

 Total market value of shares after sell all rights ..

(100 X 136) …………………………………… 13,600
 New cash balance [ 10,600 + (100 X 8)] 11,400
Total wealth (assets) 25,000
 3 Effect of right offering when exercises 60 rights and sell of
40 rights out of 100 rights
 
 No of shares increase by 30 shares i.e.
 Market price per share decreases to ex-right price (Pe)
 Cash balance increase by cash income from sale of 40 rights.

 Total market value of shares after exercise of some rights ..

[(Old share + new shares) X Pe] XXX
 New cash balance XXX
[ Old balance + cash from sale of rights – purchase value of new shares]
Total wealth (assets) XXX
Thus,

 Total market value of shares after exercise of some rights ..

[(100 + 30) X 136] = (130 X 136) ………………… 17,680
 New cash balance [ 10,600 + (40X 8) – (30 x 120)] 7,320
Total wealth (assets) 25,000
 4 Effect of right offering when all rights are discarded or
expire
 No of shares remain same (no change)
 Market price per share decreases to ex-right price (Pe)
 Cash remain same ( no change) .

 Total market value of shares after expire of rights ..

[Old share X Pe] XXX
 Cash balance [ Old balance of cash] XXX
Total wealth (assets) XXX

Thus,

 Total market value of shares after expire of rights ..

[100 X 136] 13,600
 Cash balance [ Old balance of cash] 10,400
Total wealth (assets) 24,200
 3 Effect of right offering on financial statements

 
Effect on Balance sheet:
1. Cash or bank balance increase:
New balance = old balance + amount raised
2. Common stock at increase
New balance = old balance + (new shares x par value per share)
3. Additional paid in capital (share premium account) increase.
New balance = old balance + new shares x (subscription price – par
value per share)
Effect on income statement
3. New earning per share (EPS) =
4. New market price per share = New EPS x P/E ratio
 Effect of right offering on financial statements

Specimen of balance sheet:

Assets Rupees Liabilities and equity Rupees
Cash and bank ×××  Accounts payable ×××
Marketable securities ××× Notes payable ×××
Accounts receivable ××× Accruals ×××
Inventories ×××  Total current liabilities ×××
Prepaid expenses ××× Long term debt ×××
 Total current assets ××× Preferred stock ×××
Fixed assets (net) ××× Shareholders equity:  
  Common stock at par ×××
  Paid in capital ×××
Retained earnings ×××

Total Assets ××× Total liabilities & equity ×××

 Income statement
Sales XXX
Less variable costs (VC) XXX
Contribution margin (CM) XXX
Less Fixed costs (FC) XXX
Earning before interest and taxes (EBIT) XXX
Less interest (I) XXX
Earning before tax (EBT ) XXX
Less: tax XXX
Net income (NI) or earnings after tax XXX
Less preference dividend XXX
Earning available to common equity XXX
Less dividend XXX
Retained earnings XXX
 Income statement Rupees
Net Sales ×××
Less : Cost of goods sold ×××
Gross profit …………………………………………………….. ×××
Less: Office and administration, selling and distribution expenses ×××
×××
Earning before interest, taxes, depreciation and amortization (EBITDA)
×××
Less: Depreciation and amortization …………………………
×××
Earning before interest and taxes (EBIT) or operating profit
×××
Less: Interest expenses …………………………………………..
  ×××
Earning before taxes (EBT)…………………………………………….. ×××
Less: Taxes…………(@ …% of EBT) ×××
Net income (NI) or earning after taxes (EAT)……………………… ×××
Less: Preferred dividends ( PD)
×××
Earning available to common shareholders (EACS)………………. ×××
Less: Dividend to common stockholders ×××
Retained earnings (RE)
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