Rights Issue Homework Help

Rights Issue

The methods discussed above can be used both by new companies as well as by established companies. In the case of companies whose shares an: already listed and widely-held shares can be offered to the existing shareholders. This is called rights Issue. Under this method, the existing shareholders are offered the right to subscribe to new shares in proportion to the number of shares the already hold. This offer is made by circular to shareholders only.

In India, Section 81 of the Companies Act, provides that where a company increases its subscribed capital by the issue of new shares, either after two others of its formation or after one year of first issue of shares whichever is earlier, these have to be first offered to the existing shareholders with a right to renounce them in favor of a nominee. A company can, however, dispense with this requirement by passing a special resolution to the same effect.

Rights issues are not normally underwritten but to ensure full subscription and as a measure of abundant precaution, a few companies have resorted to underwriting of rights shares. The experience of these companies has been that underwriters were not called upon to take up shares in terms of their obligations. It is, therefore, observed that such underwriting serves economically useful purpose in that it represents insurance against a risk which is (i) readily avoidable and (ii) of extremely rare occurrence even where no special steps are taken to avoid it: The chief merit of rights issue is that it is an inexpensive method. The usual expenses like underwriting commission, brokerage and other administrative expenses are either non-existent or are very small. Advertising expenses have to be incurred only for sending a letter of rights to shareholders. The management of applications and allotment is less cumbersome because the number is limited. As already mentioned, this method can be used only by existing companies and the general investing public has 100 opportunity to participate in the new companies. The right of existing shareholders may conflict with the objective of wider diffusion of share ownership.

The above discussion shows that the available methods of flotation of new issues are suitable in different circumstances and for different types of enterprises. The issue mechanism would vary from market to market.

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