The ordinary shareholders of a company enjoy rights in the sense that they have a legal right to be offered by the company the first opportunity to purchase additional issue of equity capital in proportion to basis their existing/current holdings/ownership. A shareholder owning 2 per cent or the existing issued capital is entitled/has a preemptive right to acquire 2 per cent of additional as to be issued by the company. The option to the shareholders to purchase a specified number of equity shares at a stated price during a given period is called rights. The shareholders can (i) exercise, (ii) sell. in the market and (iii) renounce/ forfeit their preemptive right partially. The shares available as a result of non-exercise of right would be allotted on a rata basis to shareholders exercising the right. And balance of shares can be offered to the public for subscription.
While the preemptive rights ensure that management cannot issue addition in shares to strengthen its control by selling them to persons groups favorably inclined to it, on one hand, it protects the existing shareholders from dilution of their financial interest as a result of new equity issues, on the other.
Assume further, shares of All. It is total wealth financial interest is (Rs 19500 , 300 x Rs 65). After the exercise of his right, his holdings will be shares. His total wealth would be Rs 23500 (400 x Rs 17,8.75), spent Rs 4.000 (Rs 40 x 100) to acquire additional shares. So his net financial Interest = Rs 23500 – Rs 4,000 = Rs 19500, that is equal to before rights issue. In case Mr X sells his right @ Rs 6.25, his total financial position in all would he Rs 19.500 Rs 5,871 x 300) + (Rs 6.25 x 300)1: the same as before the right, issue. If he does not exercise his right to buy/sell his financial interest will suffer a dilution as his total wealth = Rs 17,62. That is, a dilution of Rs 1.875 (Rs 19.500 – Rs 17,625). In brief, an investor suffers dilution of financial Interes, when he does not exercise his preemptive right.