Rights Offering

A rights offering is defined by three parameters: the subscription price at which new shares may be bought, the subscription ratio setting how many existing shares entitle the holder to one new share, and the exercise window, typically two to six weeks. On the record date, each share on the register receives one right; from the ex-rights date onward, shares trade without the entitlement attached.

The discount to the prevailing market price is a design choice, not a gift. Because the company can raise a given amount of capital either by selling few shares at a small discount or many shares at a deep discount, the size of the discount and the subscription ratio move together. A deeply discounted issue reduces the risk that the market price falls below the subscription price during the offer period, which would leave the rights worthless and the raise unfunded.

Once the shares trade ex-rights, the price adjusts mechanically. The theoretical ex-rights price is the total value of the enlarged equity divided by the enlarged share count: take the number of old shares required per new share, multiply by the cum-rights market price, add the subscription price for the one new share, and divide by that share count plus one. The result sits between the market price and the subscription price, closer to the market price when the ratio is conservative.

The value of one right equals the theoretical ex-rights price minus the subscription price, divided by the number of rights needed to buy a share. Equivalently, it is the cum-rights price minus the subscription price divided by the number of old shares per new share plus one. A holder who exercises pays the subscription price and gives up rights worth exactly that gap, so the transaction is wealth-neutral before any change in the firm's prospects.

Rights are usually renounceable, meaning they trade on exchange during the subscription period as a separate line. That tradability is what protects a shareholder who cannot or will not put up fresh cash: selling the rights converts the discount into cash instead of surrendering it. Non-renounceable rights, more common in some Asia-Pacific markets, remove that escape route and make non-participation strictly costly.

Most large issues are underwritten or supported by standby purchasers who commit to absorb unsubscribed shares, giving the company certainty of proceeds in exchange for a fee. Rights issues dominate secondary equity raising in Europe, the United Kingdom, Hong Kong and Australia, partly because pre-emption rights are embedded in company law or listing rules. In the United States, shelf registrations and marketed follow-ons are more typical, so rights offerings there often signal that conventional placement was unattractive, frequently in distressed or heavily leveraged situations.

Expect to compute the theoretical ex-rights price from a cum-rights price, subscription price and ratio, then derive the value of a right and confirm that a fully subscribing shareholder's total wealth is unchanged. You should also be able to show the outcome for a shareholder who sells the rights instead: cash received plus the lower per-share value leaves wealth intact, while ownership percentage falls.

Beyond arithmetic, be ready to discuss why the pre-emption principle exists, how the offering affects book value per share and earnings per share, and why the post-announcement share price often drifts. Distinguish the mechanical price adjustment, which is not an economic loss, from the market's assessment of why the capital is being raised and what return it will earn.