How it works
A rights issue is directly distributed as a tax free dividend to all shareholders of record or through broker dealers of record and may be exercised in full or partially. Subscription rights may be transferable, allowing the subscription-rightsholder to sell them on the open market. A rights issue to shareholders is generally made as a tax-free dividend on a ratio basis (e.g. a dividend of three subscription rights for two shares of common stock issued and outstanding). Because the company receives shareholders' money in exchange for shares, a rights issue is a source of capital.Considerations
In rights issue, the financial manager has to consider: *Engaging a dealer-manager or broker-dealer to manage the offering process *Selling group and broker-dealer participation *Subscription price per new share *Number of new shares to be sold *The value of rights vs. trading price of the subscription rights *The effect of rights on the value of the current share *The effect of rights to shareholders of record and new shareholders and rightsholdersUnderwriting
Rights issues may beOver‐subscription privilege
Some rights issues include an "over‐subscription privilege", allowing investors to buy additional shares beyond the number offered with the basic subscription privilege, if those additional shares are available. Typically the number of over‐subscription shares that can be purchased by an investor is capped as no more than the amount of his/her basic subscription. If not all the over-subscription rights can be filled, they will be partially filled on aBasic example
An investor: Mr. A had 100 shares of company X at a total investment of $40,000, assuming that he purchased the shares at $400 per share and that the stock price did not change between the purchase date and the date at which the rights were issued. Assuming a 1:1 subscription rights issue at an offer price of $200, Mr. A will be notified by a broker-dealer that he has the option to subscribe for an additional 100 shares of common stock of the company at the offer price. Now, if he exercises his option, he would have to pay an additional $20,000 in order to acquire the shares, thus effectively bringing his average cost of acquisition for the 200 shares to $300 per share ((40,000+20,000)/200=300). Although the price on the stock markets should reflect a new price of $300 (see below), the investor is actually not making any profit nor any loss. In many cases, the stock purchase right (which acts as an option) can be traded at an exchange. In this example, the price of the right would adjust itself to $100 (ideally). The company: Company X has 100 million outstanding shares. The share price currently quoted on the stock exchanges is $400 thus the market capitalization of the stock would be $40 billion (outstanding shares times share price). If all the shareholders of the company choose to exercise their stock option, the company's outstanding shares would increase by 100 million. The market capitalization of the stock would increase to $60 billion (previous market capitalization + cash received from owners of rights converting their rights to shares), implying a share price of $300 ($60 billion / 200 million shares). If the company were to do nothing with the raised money, its earnings per share (EPS) would be reduced by half. However, if the equity raised by the company is reinvested (e.g. to acquire another company), the EPS may be impacted depending upon the outcome of the reinvestment.Stock dilution
Rights offerings offset the dilutive effect of issuing more shares. For this reason, stock-exchange rules don't require that shareholders approve rights offerings if the company offers at least 20% of outstanding shares at a discount. Because rights offerings are unpopular, companies typically choose them as a last resort, perhaps due to insufficient investor demand.Tax treatment in the United States
If rights are exercised, they aren't taxed. Like with an ordinary security purchase, taxation happens when the security is sold. The cost basis of the shares is "the subscription price plus the tax basis for the exercised rights". The holding period begins at the time of exercise.IRS Pub. 550 If rights are let to expire, they don't count as a deductible loss, as they have no tax basis in this case.See also
*References
External links
{{DEFAULTSORT:Rights Issue Corporate finance