Definition
A Subscription Right or Warrant is a contractual right given to existing shareholders to purchase additional shares of a new issue of common stock before it is offered to the public. This right is designed to protect existing shareholders from dilution of their ownership stake in the company. Rights typically must be exercised within a short time frame (measured in days or weeks), while warrants usually have an expiration date measured in months or years.
Key Characteristics:
- Preemptive Right: Allows shareholders to maintain their proportionate ownership in the company.
- Expiration: Rights have a short lifespan (days or weeks), while warrants have longer expiration periods (months or years).
- Exercise Price: Typically set at a price lower than the market price during the issuance period.
- Tradability: Rights are often non-transferable, lasting for a limited time, while warrants can often be traded until their expiration.
Examples
- Company A Rights Issue: Company A announces a rights issue where each existing shareholder receives a right to purchase additional shares at a 20% discount to the current market price within 30 days.
- Company B Warrants: Company B issues warrants to shareholders as part of a new financing round. These warrants allow shareholders to buy additional shares at a fixed price anytime within the next three years.
Frequently Asked Questions
Q1: What is the main benefit of subscription rights for shareholders?
A1: Subscription rights protect shareholders from dilution by allowing them to buy additional shares at a discounted price before public offering.
Q2: Can subscription rights be sold or transferred?
A2: It depends on the terms set by the company. Some rights are non-transferable, while others can be sold or traded in the open market.
Q3: What happens if a shareholder does not exercise their right?
A3: If the shareholder does not exercise their right within the specified period, the right expires, and the shareholder’s ownership percentage in the company may be diluted as new shares are issued to the public.
Q4: How does a warrant differ from a right?
A4: A warrant typically has a longer expiration period (months to years) and can often be traded independently of the shares, while a right has a short expiration period (days to weeks) and may be non-transferable.
Q5: Are warrants always issued during a rights offering?
A5: No, warrants can be issued independently as part of various financial instruments like bonds or preferred stock to make them more attractive.
- Dilution: The reduction in existing shareholders’ ownership percentage due to the issuance of additional shares.
- Rights Issue: An offering of rights to existing shareholders to buy additional shares in proportion to their holdings.
- Stock Options: Financial derivatives that give the right, without obligation, to buy or sell stock at a set price before a particular date.
- Preemptive Right: The right of existing shareholders to purchase new shares before they are offered to the public.
- Convertible Bonds: Bonds that can be converted into a predetermined number of the issuing company’s shares.
Online References
Suggested Books for Further Studies
- “Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions” by Joshua Rosenbaum and Joshua Pearl
- “The Essays of Warren Buffett: Lessons for Corporate America” by Warren Buffett
- “Security Analysis” by Benjamin Graham and David Dodd
- “Options, Futures, and Other Derivatives” by John C. Hull
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
Fundamentals of Subscription Rights and Warrants: Corporate Finance Basics Quiz
### A subscription right allows existing shareholders to purchase additional shares:
- [x] Before they are offered to the public.
- [ ] After the public offering but before closing.
- [ ] Whenever the shareholder chooses without any time limit.
- [ ] Only if they were initial investors.
> **Explanation:** Subscription rights allow existing shareholders the opportunity to purchase additional shares before they are offered to the public, giving them the chance to maintain their ownership percentage.
### How long do rights typically last?
- [ ] Years
- [ ] Several months
- [ ] Until the shareholder chooses to exercise them
- [x] Days or weeks
> **Explanation:** Rights typically have a short duration, lasting only days or weeks, to create a time-bound opportunity for shareholders to exercise their right.
### What is a common incentive for shareholders to exercise a subscription right?
- [x] The ability to buy shares at a discounted price.
- [ ] Guaranteed profit after public offering.
- [ ] A refund if shares underperform.
- [ ] The right lasts forever.
> **Explanation:** A common incentive is that shareholders can purchase additional shares at a discounted price, usually lower than the current market value.
### How does a warrant differ in the timeframe compared to a right?
- [ ] It has the same short expiration period.
- [x] It has a longer expiration period, usually months or years.
- [ ] It does not expire.
- [ ] It must be exercised immediately.
> **Explanation:** Warrants typically have a longer expiration period, usually spanning several months or years, as opposed to the short life span of days or weeks seen in rights.
### What is the primary purpose of issuing rights to existing shareholders?
- [ ] To penalize the general public from buying shares.
- [ ] To dilute the ownership of long-time shareholders.
- [x] To protect existing shareholders from dilution of their ownership percentage.
- [ ] To inflate the company's stock price artificially.
> **Explanation:** The main purpose is to protect existing shareholders from dilution, allowing them to maintain their proportional ownership in the company.
### Can warrants typically be traded separately from the company's stock?
- [x] Yes
- [ ] No
- [ ] Only in special circumstances
- [ ] Never
> **Explanation:** Warrants can often be traded independently from the company’s stock, allowing flexibility in their exercise and sale.
### If shareholders do not exercise their rights, what happens?
- [ ] The rights get automatically converted into common stock.
- [ ] The shareholders still retain priority purchase options in the future.
- [x] The rights expire, and their proportional ownership might be diluted.
- [ ] No impact on the shareholder or their ownership percentage.
> **Explanation:** If rights are not exercised within the specified time frame, they expire, and the existing shareholders’ ownership percentage may be diluted once new shares are issued to the public.
### Why might a company issue warrants to its shareholders?
- [ ] To decrease the company’s share value.
- [ ] To avoid issuing new shares.
- [x] As an incentive to attract investment or raise funds.
- [ ] To reduce shareholder rights.
> **Explanation:** Companies may issue warrants as incentives to attract investment or raise funds, as they provide an option to buy shares at a fixed price in the future.
### Who generally has the right to participate in a rights offering?
- [ ] Any potential future investor.
- [ ] Only employees of the company.
- [x] Existing shareholders.
- [ ] Randomly selected participants.
> **Explanation:** Rights offerings are generally available to existing shareholders, allowing them to maintain their ownership level by purchasing additional shares.
### In what cases are subscription rights typically non-transferable?
- [ ] When issued after a public offering.
- [ ] When the company is private.
- [ ] All rights are always transferable.
- [x] Depending on the terms set by the issuing company.
> **Explanation:** The transferability of subscription rights depends on the terms set by the company issuing the rights. Some rights may be non-transferable, especially if stipulated in the offering conditions.
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