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Rights Issue

Investment

Rights Issue of Shares

A method by which a listed company raises additional capital by offering new shares to existing shareholders at a discounted price, in proportion to their current holding. Shareholders can subscribe, sell, or renounce their rights.

Definition

A rights issue is a mechanism by which a listed company raises additional capital by offering new shares to its existing shareholders, in proportion to their current holdings, at a price typically below the prevailing market price.

The proportion is expressed as a ratio, for example, a "1:5 rights issue" means for every 5 shares you hold, you have the right (but not the obligation) to buy 1 new share at the rights price.

Shareholders have three choices: subscribe (buy the new shares at the rights price), sell the rights entitlement in the secondary market, or let the rights lapse (losing their entitlement without compensation).

Formula

Shares entitled = Existing shares held × (Rights ratio)

Amount to pay = Shares entitled × Rights issue price

Theoretical Ex-Rights Price (TERP) = (Existing shares × Market price + New shares × Rights price) / (Existing shares + New shares)

TERP is the theoretical stock price after the rights issue, useful for evaluating dilution.

Worked Example

You hold 500 shares of XYZ Ltd at ₹200 each (total value ₹1,00,000). The company announces a 1:5 rights issue at ₹150.

  • Shares entitled = 500 / 5 = 100 shares
  • Cost to subscribe = 100 × ₹150 = ₹15,000

TERP = (500 × ₹200 + 100 × ₹150) / 600 = (₹1,00,000 + ₹15,000) / 600 = ₹191.67

If you subscribe: You own 600 shares at an average cost of ₹(1,00,000 + 15,000)/600 = ₹191.67. Your total investment = ₹1,15,000.

If you don't subscribe and don't sell rights: You own 500 shares worth ₹191.67 each = ₹95,835. You've lost ₹4,165 in value compared to the TERP, representing the dilution from not participating.

Key Things to Know

  • Dilution: A rights issue increases shares outstanding. If you don't subscribe or sell your rights, your percentage ownership of the company falls, dilution. Even if you subscribe, your ownership percentage is maintained but you've had to invest more capital.
  • Rights price below market = instant paper profit: If the rights price is ₹150 and the market price is ₹200, subscribing and immediately selling appears profitable. In practice, the stock price adjusts to TERP on ex-rights date, eliminating the arbitrage. The real value lies in the long-term use of the capital raised.
  • Compare to bonus issue: A bonus issue is free, shareholders get more shares without paying anything, funded from reserves. A rights issue requires payment. Both increase shares outstanding but a bonus issue doesn't raise new capital while a rights issue does.
  • Rights issue quality signal: Companies in financial distress sometimes use rights issues to plug losses. A healthy company raises capital for expansion. Always examine the stated purpose: debt reduction and growth capex are positive signals; plugging operating losses are negative signals.
  • Renouncement: If you don't want to subscribe but want to pass the rights to someone else (a family member, for example), you can "renounce" the rights, transferring the entitlement without selling it on the exchange. This is common for rights in closely-held companies.

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Related Terms

Bonus IssueBonus Share IssueBook ValueBook Value per ShareP/E RatioPrice-to-Earnings RatioNAVNet Asset Value

Frequently Asked Questions

Evaluate it like any new investment in the company. Ask: Is the capital being used for value-creating purposes (expansion, debt reduction) or to cover operating losses? Is the rights price a meaningful discount to the current market price? Is the company financially healthy with a credible plan? If you wouldn't buy the stock at the market price, there's no reason to subscribe at the rights price just because it's offered to you.
If you don't subscribe and don't sell your rights entitlement in the market, your rights lapse and you receive nothing. Meanwhile, the new shares are issued to subscribers, increasing total shares outstanding. Your existing shareholding percentage is diluted. If the rights price is below market price, your economic value is also diluted, this is why you should either subscribe, sell rights, or actively evaluate.
Yes. During the rights issue period, the rights entitlement (RE) is tradeable on stock exchanges as a separate instrument. If you don't want to invest more but don't want to lose value, you can sell your RE in the market. The RE's market value should approximate the difference between the current stock price and the rights issue price.
The record date is the date by which you must hold shares to be eligible for the rights entitlement. The ex-rights date is the date from which the stock trades without the rights attached. On the ex-rights date, the stock price typically adjusts downward to reflect that the rights have been separated.
A rights issue offers new shares exclusively to existing shareholders (pro-rata). A Follow-on Public Offer (FPO) offers new shares to the general public as well. Rights issues are faster, cheaper, and maintain the existing shareholder base's ownership. FPOs open to the broader market and are typically used for larger capital raises.