Rights Issue

Rights Issue Pre-Emption Rights Capital Raising Stock Exchange New Shares Shareholders Discounted Shares Market Offering
A method by which listed companies on a stock exchange raise new capital by offering new shares to existing shareholders. This concept is based on pre-emption rights, ensuring existing shareholders can purchase new shares proportionally to their existing holdings.
On this page

Definition

A rights issue is a method by which publicly-listed companies raise new capital. In a rights issue, the company offers new shares to its existing shareholders proportionally to their current holdings. This process is grounded in the principle of pre-emption rights, whereby existing shareholders have the right to purchase additional shares before the company offers them to the public. New shares in a rights issue are typically issued at a discount to the market price, providing an incentive for current shareholders to participate.

Examples

  1. 1 for 4 Rights Issue: If a company issues a 1 for 4 rights issue, it means that shareholders can purchase one new share for every four shares they already own. If an investor holds 400 shares, they would be eligible to buy 100 new shares at the discounted price.

  2. Discounted Price: Assume a company’s current share price is $20, and it announces a rights issue with a 20% discount. The new shares may be offered at $16. Existing shareholders can either purchase these shares or sell their rights in the open market if they choose not to participate.

Frequently Asked Questions (FAQ)

Q1: What are pre-emption rights? A1: Pre-emption rights are rights that give existing shareholders the first opportunity to buy new shares issued by the company, in proportion to their current holdings.

Q2: Why do companies issue rights? A2: Companies issue rights to raise capital for various purposes such as paying off debt, funding new projects, or expanding operations.

Q3: Can shareholders sell their rights? A3: Yes, shareholders can sell their rights in the open market if they choose not to purchase the additional shares.

Q4: How is the issue price of new shares determined in a rights issue? A4: The issue price is usually set at a discount to the current market price to make it attractive for existing shareholders.

Q5: What happens if shareholders do not take up their rights? A5: Unused rights may be sold in the market or become void, and the company might offer the shares to new investors.

  • Bought Deal: A method where an underwriter buys an entire issue of stock from the company and sells it to investors.
  • Vendor Placing: A method in which shares are sold directly to selected investors rather than through a public offering.
  • Scrip Issue: An issue of additional shares to existing shareholders without any capital raising, often in lieu of dividends.

Online Resources

Suggested Books for Further Studies

  • “The Intelligent Investor” by Benjamin Graham – A classic book on investing that touches on various aspects of stock market operations.
  • “Security Analysis” by Benjamin Graham and David Dodd – Delves deeper into the evaluation of securities and the functioning of markets.
  • “Corporate Finance” by Jonathan Berk and Peter DeMarzo – Covers a broad range of corporate finance topics, including different methods of raising capital.

Accounting Basics: “Rights Issue” Fundamentals Quiz

### What is a rights issue? - [ ] A method where a company buys back its shares from the market. - [x] A way for companies to raise new capital by offering shares to existing shareholders. - [ ] A process where shares are issued to new investors only. - [ ] A mandatory buyout of company shares by the government. > **Explanation:** A rights issue is a method for companies to raise new capital by offering new shares to existing shareholders in proportion to their current holdings. ### What principle is the rights issue based on? - [ ] Market pricing rights - [x] Pre-emption rights - [ ] Stock dividend rights - [ ] Convertible rights > **Explanation:** The rights issue is based on pre-emption rights, ensuring that existing shareholders are offered the new shares before the public. ### What happens if a shareholder does not take up their rights? - [ ] They must buy double the rights next time. - [ ] Their rights automatically transfer to new shareholders. - [ ] The rights are void and cannot be sold. - [x] They can sell their rights in the market. > **Explanation:** If shareholders do not wish to take up their rights, they have the option to sell them in the market. ### At what price are new shares typically offered in a rights issue? - [ ] At the market price - [ ] Above the market price - [x] At a discount to the market price - [ ] At a premium to the market price > **Explanation:** New shares in a rights issue are typically offered at a discount to their current market price to incentivize shareholders to purchase them. ### What is the key benefit for shareholders in a rights issue? - [ ] They receive increased dividends immediately. - [x] They can buy additional shares at a discounted price. - [ ] They can convert their shares into preferred stock. - [ ] They are exempt from taxes on these shares. > **Explanation:** The key benefit is that shareholders can buy additional shares at a discounted price, potentially increasing their overall holding at a lower cost. ### Which type of rights issue allows shareholders to sell their rights? - [ ] Mandatory take-up rights issue - [x] Tradable rights issue - [ ] Non-tradable rights issue - [ ] Synthetic rights issue > **Explanation:** In a tradable rights issue, shareholders have the option to sell their rights if they choose not to purchase the additional shares. ### What does a “1 for 4 rights issue” mean? - [ ] Shareholders receive one bonus share for every four shares sold. - [ ] Shareholders must sell one share for every four they own. - [x] Shareholders can buy one new share for every four shares they already own. - [ ] The company will cancel one share out of every four. > **Explanation:** A “1 for 4 rights issue” means that shareholders can buy one new share for every four shares they already hold, at a discounted price. ### Why might a company undertake a rights issue? - [ ] To decrease the company's capital base. - [x] To raise additional capital. - [ ] To reduce the number of outstanding shares. - [ ] To convert debt into equity. > **Explanation:** Companies undertake rights issues primarily to raise additional capital for purposes such as expansion, paying off debt, or funding new projects. ### What could happen to the share price immediately after a rights issue? - [ ] It always increases significantly. - [ ] It remains unaffected by any means. - [x] It could decrease because of dilution. - [ ] It becomes tax-free briefly. > **Explanation:** The share price might decrease immediately after a rights issue due to the dilution of the existing shares and the discounted price of the new shares. ### Which regulatory body oversees rights issues in the United States? - [x] The Securities and Exchange Commission (SEC) - [ ] The Federal Reserve Board - [ ] The Department of Commerce - [ ] The Internal Revenue Service (IRS) > **Explanation:** In the United States, the Securities and Exchange Commission (SEC) oversees rights issues and ensures that companies comply with the regulatory requirements.

Thank you for exploring the concept of rights issues and testing your understanding through our comprehensive quiz! Continue to broaden your financial knowledge for better investment decisions.

Tuesday, August 6, 2024
Rightsizing
Right-to-Work Law
Allotted Shares January 1, 1
Equity Finance January 1, 1
Equity Financing January 1, 1
Ex-Rights January 1, 1
Flotation January 1, 1
Nil Paid Shares January 1, 1
Placing January 1, 1
Pre-Emption Rights January 1, 1
Stock Exchange January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.