Through which an already listed company can issue fresh shares to its already existing shareholders without changing their ownership in the company. Here shares are issued based on the current holdings of the existing shares and it won’t change the number of shareholders.
For right issue, the shares are offered at much discount to the existing shareholders to make them subscribe for the same. If they subscribe then their number of shares is increased and value is decreased to keep the total amount same. If they don’t subscribe their value is diluted because of the share value dilution, leading to losing value.
It may not be necessary that the retail investors have the surplus money or are willing to invest more in the company. That’s why right issues are mainly issued to the promoters who can invest more money in the company rather than normal retail shareholders.
Let us check the below example to understand the whole process.
Suppose one shareholder has 1000 shares of Company XYZ and the current share price is USD 200 which makes his total invested value as USD 200,000.
Now the right shares are issued at 1:1 ratio to all the existing shareholders at much discounted price of USD 100.
Now after the right issue, the share price will be corrected to consider the new shares at much discounted rate. After the right issue, the share price will be USD 150 ((200+100)/2).
Now if the investor subscribe to the right issues then he has to invest another USD 100,000 to get the new 1000 shares.
After the issue of right shares, the investor will have total 2000 shares of value USD 150 making the total invested value as USD 300,000. This is same as the earlier investment value which did not change because of the right issue.
If the investors won’t subscribe the issue then his investment value will drop to USD 150,000 because of the lower share price. So he will lose USD 50,000 if he won’t subscribe to the right issue.
From the company point of view, if the company has 1 million shares before the right issue and all the shareholders subscribe for the same then the total number of shares will be 2 million.
The market cap was USD 200 million and money raised through right issue will be USD 100 million. After the right issue, the combined market cap will be USD 300 million (2 million * USD 150). So there will be no change in the overall market cap of the company but it will be able to raise further USD 100 million through the right issue.
As it impacts the total number of share it will dilute or reduce the EPS by 50% in the short term. But in the long term company is expected to invest USD 100 million for expansion which will also increase the EPS in the long run.
So we can say that right issue helps the company to raise money without any borrowing cost but it is bad for shareholders. Shareholders don’t have any other option except subscribing in the right issue.