What is Right issue of Share?
Rights shares are those shares which are issued to the existing shareholders, in proportion to the size of their shareholding. Rights issues are cheaper to organize than a public share issue.
CIMA defined Rights issue as :
” Raising of new capital by giving existing shareholders the rights to subscribe to new shares in proportion to their current holdings. These shares are usually issued at a discount to market price.”
Determination of Issue Price
1. Selection of an issue price:
The issue price is normally set at a discount on prevailing market price (MPS) of the shares. The discount normally 20% or nearer to 20%. Theoretically you may observe there is no lower limit of issue price , but in practice it can never be lower than the nominal value of the shares.
2. Selection of an issue Quantity:
Firstly issue price to be selected and then the quantity of shares to be issued become a passive decision. Earnings per share, Dividend Per Share and Dividend Cover should be considered.
3. Market reaction after rights issue:
After announcement of a rights issue there is a tendency for share prices to fall. Price falls temporarily due to consequence of the issue, future profits, future dividends.
Cum-Rights and Ex-Rights
When a rights issue is announced, existing shareholders have the right to subscribe for new shares, and so there rights (cum rights) attached to the shares, and the shares are traded cum rights.
On the first day of dealing in the newly issued shares, the rights no longer exist and the old shares are now traded ‘ex rights’ without rights attached.
Theoretical ex rights price are =
Market value of shares cum-rights+rights proceeds+project NPV / Number of shares ex-rights.
Reasons for a Right issue
- Less complicated and cheap cost:
A company may require huge amount of capital to expand its business. They may searching for the fund which is less expensive and less complicated. If they want to raising fund from the debt, huge amount of interest to be paid as well as processing cost for the loan disbursement may also require. If they plan for public issue, it would be subjected to large amount of issue cost, underwriting fees and also time consuming. For these reasons the management of the company always concentrate on right issue of shares for its easy process and less costs.
2. A source of urgent fund:
Sometimes urgent fund may be needed for taking a profitable project/business, in that case right issue is considered as the most suitable option for getting the fund. Debt and public issue both are time consuming because both are needed a processing time and should maintain several official formalities.
3. To improve Debt equity ratio:
Right issue reducing the gearing ratio of the company and shareholder’s don’t worried about their shareholdings and the future of the company.
4. Have option of selling the rights:
Sometimes shareholders may not want to exercise the rights. In this case the shareholders may sell their rights to other shareholders or to outsider investors with the permission of the board.
Factors to consider before rights issue
- Issue costs : Though issue costs are very lower than public issue, the amount to be determined for making the plan
- Dividend Payments for the right issue: – There is common misconception that right issue is cost less which is not true because shareholders will want dividends for their new shareholdings also.
- Shareholders reactions: – shareholders may react badly if the firm continuously issue right share. Shareholders may sell their shares to the company and driving down the market price.