Rights Issue
Rights Issue is a method by which listed companies raise fresh capital by offering existing shareholders the right to buy additional shares at a predetermined price. It tests your understanding of corporate finance, shareholder rights, and SEBI regulations – all high‑frequency exam topics. This sub‑topic links the concepts of dilution, pricing, and entitlement ratios, which appear in many NISM questions.
Learning Objectives
- 1Define a rights issue and differentiate it from other corporate actions.
- 2Explain the entitlement ratio, pricing, and key dates.
- 3Calculate the Theoretical Ex‑Rights Price (TERP) and value of a right.
- 4Identify the impact of a rights issue on shareholding, EPS and investor decisions.
What is a Rights Issue?
A rights issue is an offer made by a listed company to its existing shareholders to subscribe to newly issued shares in proportion to their current holdings. The company raises fresh equity capital without resorting to public offerings, thereby preserving control and reducing underwriting costs.
The offer price is usually set at a discount to the prevailing market price to make the rights attractive. SEBI (Issue of Capital and Disclosure) Regulations mandate that the discount cannot exceed 20% of the market price on the record date, unless the Board obtains a special exemption.
For the NISM exam, you must remember that a rights issue is a *renounceable* or *non‑renounceable* entitlement, not a bonus issue or a stock split. The exam often asks you to identify the correct definition or to pick the right regulatory provision.
A bonus issue is a free allotment of shares, whereas a rights issue requires shareholders to pay a subscription price. Remember: only rights issues involve cash flow and a discount.
Types of Rights Issues
There are two major classifications:
- Renounceable Rights – Shareholders can sell or trade the right on the stock exchange during the subscription period.
- Non‑renounceable Rights – The right is strictly personal; it cannot be traded and must be either exercised or forfeited.
Renounceable rights are more common in India because they provide liquidity and help price discovery. Non‑renounceable rights are typically used in private placements or when the company wants to limit market speculation.
Exam questions may ask you to choose the correct type for a given scenario, such as “the right is listed on BSE during the subscription window – which type is it?”
Key Dates and Process
The rights issue timeline consists of four critical dates:
- Record Date – The cut‑off date on which shareholders of record become eligible to receive rights.
- Ex‑Rights Date – Usually one business day before the record date; the share price adjusts for the pending rights.
- Subscription Period – The window (typically 5‑15 days) during which shareholders can subscribe, sell, or renounce their rights.
- Issue Date – The date on which the newly allotted shares are credited to the shareholder’s demat account.
Understanding the sequence is vital because the exam often presents a calendar and asks you to identify the correct date for a particular action.
The ex‑rights date is *before* the record date. The share price drops on the ex‑rights date, not on the record date.
Entitlement Ratio and Pricing
The entitlement ratio specifies how many new shares a shareholder can purchase per existing share. It is expressed as a fraction, e.g., 1:5 means one new share for every five held.
The subscription price is set by the board and is usually lower than the market price on the record date. The discount is calculated as (Market Price – Subscription Price) ÷ Market Price × 100%.
For exam purposes, you may be given the market price, subscription price, and ratio, and asked to compute the discount or the number of rights a shareholder will receive.
Where:
M= Number of existing shares held by the shareholderP_{0}= Market price per existing share on the record date (in rupees)R= Number of new shares allotted under the rights issueS= Subscription price per new share (in rupees)Worked Example
Given M = 100, P₀ = 150, entitlement ratio 1:5 → R = 20, S = 120: Step 1: Compute numerator = (100 × 150) + (20 × 120) = 15000 + 2400 = 17400 Step 2: Compute denominator = 100 + 20 = 120 Step 3: TERP = 17400 ÷ 120 = 145 Verification: ((100×150)+(20×120))/(100+20) = 145
Renounceable vs Non‑renounceable Rights
| Feature | Renounceable | Non‑renounceable |
|---|---|---|
| Tradeability | Can be sold on exchange | Cannot be sold |
| Liquidity | High – creates market price | Low – only exercised or forfeited |
| Investor Choice | Can retain, sell, or renounce | Must either subscribe or let lapse |
| Typical Use | Large public issues | Private placements or strategic allocations |
Impact on Shareholding and Dilution
When shareholders fully exercise their rights, the proportion of ownership remains unchanged, but the total number of shares outstanding increases, leading to dilution of earnings per share (EPS) if the new capital is not immediately earnings‑generating.
If a shareholder does not exercise the rights, their ownership percentage falls, and the value of each share may decline. The TERP reflects the new equilibrium price after dilution.
Exam questions often present a scenario where a shareholder partially subscribes and ask for the resulting shareholding percentage or EPS impact. Remember to adjust the denominator (total shares) accordingly.
Share Price Before and After Rights Issue (Illustrative)
Scenario
ABC Ltd announces a 1:4 renounceable rights issue at a subscription price of ₹120. The market price on the record date is ₹150. An investor holds 200 shares. Calculate (a) the number of rights allotted, (b) the discount percentage, (c) the TERP, and (d) the value of one right.
Solution
Step 1: Rights allotted = 200 ÷ 4 = 50 rights. Step 2: Discount = ((150‑120) ÷ 150) × 100 = 20%. Step 3: Use TERP formula: M=200, R=50, P₀=150, S=120 → TERP = ((200×150)+(50×120))/(200+50) = (30000+6000)/250 = 36000/250 = 144. Step 4: Value of one right = (P₀‑S) ÷ (R+1) = (150‑120) ÷ (50+1) = 30 ÷ 51 ≈ 0.588 ≈ ₹0.59.
Conclusion
The investor receives 50 rights, enjoys a 20% discount, and the post‑issue theoretical price settles at ₹144. The per‑right value of about ₹0.59 helps decide whether to sell or exercise the rights.
Partial Subscription and Oversubscription
Shareholders may choose to subscribe to only a part of their entitlement. The unexercised portion is either forfeited or, in case of renounceable rights, can be sold on the exchange.
Oversubscription occurs when the total demand exceeds the number of rights offered. Companies may allocate shares on a pro‑rata basis, use a lottery, or accept excess applications and refund the surplus amount.
In the exam, you might be given an oversubscription ratio and asked to compute the final number of shares allotted to a particular investor.
Never assume all shareholders will fully subscribe. The exam may test your ability to adjust total shares for partial uptake.
Regulatory Framework (SEBI)
SEBI (Issue of Capital and Disclosure) Regulations, 2006 govern rights issues. Key provisions include: (i) Minimum 25% of the issue must be offered to existing shareholders; (ii) Discount cannot exceed 20% of the market price on the record date unless a special exemption is obtained; (iii) Detailed disclosure of purpose, pricing, and use of proceeds in the prospectus.
The regulations also require a minimum subscription of 90% of the rights offered; otherwise, the issue may be aborted or the company may seek shareholder approval for a revised issue.
Exam questions frequently ask which regulation mandates the 90% minimum subscription or the 20% discount cap.
Practical Considerations for Investors
Investors should evaluate the cost of participation (subscription price plus transaction costs) against the expected benefit (discount and potential appreciation). The decision also hinges on the investor’s view of the company’s future earnings and whether dilution will be offset by growth.
Tax implications: In India, the discount component is treated as a capital gain when the shares are sold, while the subscription price forms part of the cost base for future capital gains calculations.
For the NISM exam, remember to mention both financial and regulatory factors when answering ‘should an investor participate?’ type questions.
⭐Exam Takeaways
- A rights issue offers existing shareholders the option to buy new shares at a discount; it is not a free bonus issue.
- Entitlement ratio (e.g., 1:5) determines the number of rights; subscription price is set by the board within SEBI‑prescribed limits.
- Theoretical Ex‑Rights Price (TERP) is calculated using \(( (M \times P_{0}) + (R \times S) ) \div (M + R)\) and reflects the new equilibrium share price after dilution.
- Renounceable rights can be sold on the exchange; non‑renounceable rights cannot be traded.
- Key dates: Record date, ex‑rights date (price adjusts), subscription period, and issue date; ex‑rights precedes record date.
- SEBI mandates a maximum 20% discount and at least 90% subscription; failure may lead to aborting the issue.
- Partial subscription reduces dilution; oversubscription is allocated on a pro‑rata or lottery basis.
- Investors must weigh the discount, transaction costs, and potential dilution against the company’s growth prospects.
Practice Questions
8 questions on Rights Issue
What best describes a rights issue?
Under SEBI (Issue of Capital and Disclosure) Regulations, the discount on a rights issue cannot exceed what percentage of the market price on the record date without a special exemption?
If a right can be sold on the stock exchange during the subscription period, it is classified as:
A company announces a rights issue with a market price of ₹200 on the record date and a subscription price of ₹160. What is the discount percentage?
An investor holds 150 shares. The entitlement ratio is 1:3, the market price on the record date is ₹180 and the subscription price is ₹140. What is the Theoretical Ex‑Rights Price (TERP) after full subscription?
A shareholder owns 120 shares. The rights issue is 1:4 and the subscription price is ₹130 while the market price on the record date is ₹150. The shareholder subscribes to only half of the rights allotted to him. After the issue, what is his percentage ownership assuming the total shares outstanding before the issue were 1,000,000?
On which date does the share price typically adjust downward in a rights issue?
A rights issue is 1:5, offering 200,000 new shares. Total applications received correspond to an oversubscription ratio of 2:1. An investor applies for 500 rights. How many new shares will be allotted to him on a pro‑rata basis?