What will be the effect on issue of right shares? Why it is not issued in market directly? Will the shareholders be at any profit/loss? Let us move by defining it and the case onwards.
What is right issue of shares?
Right shares are simply the shares issued to the existing shareholders of the company at a discounted price by the company. It is called so because the existing shareholders have the “right” to buy it, sell it or ignore it. For e.g. – Say the market price of share is Rs. 1500, then the company will offer right shares at less than Rs. 1500 say Rs. 1000.
Why right shares are issued when they can be issued directly in market at the market price?
1. To save floatation cost: As the company issuing shares would be in dire need of capital and as we know that the cost of floating the shares is very high as compared to shares issued as right shares.
2. Preserve rights of shareholders: Shares are not issued to new shareholders because company wants the voting rights to remain vested upon the existing shareholders. This increases the confidence of the existing shareholders.
3. Problem raising funds from the market: If company faces any problem while raising funds from the market by issuing the shares.
Will there be any effect on the value of shares?
Yes, price of shares will go down. Suppose CJ Ltd. has 10 Lakhs shares at market price of Rs. 1500 per share. Company wants to issue right shares at Rs. 1000. 1 right share will be given for every 5 shares held.
Theoretical ex-right price (Market price of share calculated after issue of right shares)
Note: No of right shares = 10 Lakhs/5 = 2 Lakhs shares @ Rs. 1000 per share
Here we can see that the price of share after issuing right shares will be Rs. 1417 as compared to price of Rs. 1500 before issue.
Will there be any effect on wealth of shareholders?
No, if the right is exercised but if it is not exercised then wealth will go down. Continuing with the example, assume that a shareholder F holds 2000 shares. Let us first find out the value of “right” which means what is the benefit which is given to the shareholders while issuing right shares. This can be calculated as:
Ex-right price – Price at which right shares were issued = 1417 – 1000 = Rs. 417
Rights were exercised
Value of shares before issue = 2000 shares* 1500 per share = 30 Lakhs.
Value of shares after issue = 2000 shares* 1417 per share = 28.34 Lakhs.
Value of right shares received = 400 shares* 1417 per share = 5.66 Lakhs.
Amount paid for right shares = 400 shares* 1000 per share = 4 Lakhs.
Net wealth after issue = (28.34 + 5.66 – 4) = 30 Lakhs.
Wealth remains at Rs. 30 Lakhs.
Rights were exercised – Sold
When the rights are sold in market, then value of rights received will be the gain.
Value of shares before issue = 2000 shares* 1500 per share = 30 Lakhs.
Value of shares after issue = 2000 shares* 1417 per share = 28.34 Lakhs.
Value of rights received = 400 shares* (1417 – 1000) per share = 1.66 Lakhs.
Net wealth after issue = (28.34 + 1.66) = 30 Lakhs.
Wealth remains at Rs. 30 Lakhs.
Rights were ignored and not exercised
Value of shares before issue = 2000 shares* 1500 per share = 30 Lakhs.
Value of shares after issue = 2000 shares* 1417 per share = 28.34 Lakhs.
Net Loss = 1.66 Lakhs.
Is there any risk when a company is issuing right shares?
Sometimes yes due to:
- Poor credit rating – Bank is unwilling to give loan to the company due to poor credit rating or risk associated with it. It creates a question on the ability of the company. It may be due to the company not performing well, its sales or receipts are going down or dimming future prospects.
- Unable to float shares in market – Company may be out of funds to pay even for the floatation cost. There may be a lack of demand of its share in the market so there is a risk of under subscription for the company. It also questions the company’s ability to perform in the market.
If shares are sold before the announcement, will it be at risk to new shareholders?
Yes, sometimes, information about company’s internal affairs can be leaked by any insider of the company (Insider Trading - How is it done?). In that case, price will increase of the shares and will be sold at premium in the market. Now, if there will be no announcement of issue of right shares then prices of shares will go down and new shareholders will be at loss.
Chiranjiv Kumar
CAclubindia
