Meaning of Right Issue:
Rights Issue (RI) is when a listed company which proposes to issue fresh securities to its existing shareholders as on a record date. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. The company is under legal obligation to offer first the further issue of the shares to its existing shareholders. But the holders have option either to accept it or to reject or renounce it. That is why this is called “Right Issue”.
Advantages of Right Issue
The following are the main advantages of right issue:
1. Right issue gives the existing shareholders an opportunity to maintain their pro-rata share in the earning and surplus of the company and the voting power as before.
2. The goodwill of the company increases in the eyes of existing shareholders.
3. The cost of issue of such shares will also be lower.
4. No pressure of selling the shares.
5. If right shares are offered by the shareholders enthusiastically, it proves that financial position of the company is sufficiently good, and the company can obtain more loans at lower rate of interest.
Provisions Regarding Right Issue:
Section 81 of the Companies Act dealing with Right Issue, provides that whenever a company proposes to increase its subscribed capital (within the limits of the authorized capital) by allotment of further shares any time after the expiry of two years of its formation or any time after the expiry of one year from the first allotment of shares whichever is earlier, then -
1. Such further shares (i.e., new shares) must be offered to the existing holders of equity shares in the company.
2. The offer is to be made giving a notice specifying the number of shares offered. The notice must fix a time, which should not be less that 15 days from the date of the offer within which the offer must be accepted.
3. Unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercised by the person concerned to renounce the shares offered to him or any of them in favour of any other person; and the notice referred to in clause (b) shall contain a statement of this right.
4. After the expiry of the time specified in the notice aforesaid or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered, the Board of Directors may dispose of them in such a manner as they think most beneficial to the company.
Thus, the company is under legal obligation to offer first the further issue of the shares to its existing shareholders. But the holders have option either to accept it or to reject or renounce it. This right is called the ‘Right Issue’.
The object of Section 81 obviously is that there should be an equitable distribution of shares and the issue of new shares should not affect the holding of shares by each shareholder. The operation of this section can, however, be excluded and new shares may be offered to outsiders to the total exclusion of the existing shareholders in the following two cases mention in Section 81 (1A):
1. If the company at a general meeting passes a special resolution authorizing the board to allot shares to outsiders; or
2. If an ordinary resolution to that effect has been passed and the Central Government is satisfied on an application made by the Board of Directors that the proposed offer of shares to the outsiders is most beneficial to the company.
Calculation of the Value of Right
There is a specific advantage available to the existing shareholders of a company because of this legal right especially when the market value of the share is more than the issue price. Thus there is good demand for the shares in such cases. The quotations of the existing shares tend to go up whenever there is a ‘right issue’. The procedure outlined below is adopted to calculate the value of this right:
1. Calculate the market value of the shares held by a shareholder. While calculating the market value, it is essential to find out the rate or basis of ‘right issue’. For example, if the company makes a right issue of one share for every five shares held, then a shareholder must hold five shares to claim one share under right issue. Suppose a shareholder holds only four shares, he will have to buy one more share from the market in order to get himself entitled to one share under the right. If the market value of one share of Rs. 100 each, fully paid is Rs. 150, the total market value of five shares is 5 x Rs. 150 = Rs. 750.
2. The amount paid to the company for the right share should be added to the total market value of required number of shares held [This is done to find out the total price of all the shares]. For example, if the company is issuing a fresh share under right issue at a premium of Rs. 25, the shareholder will add Rs. 125 to the market value of five shares held by him. Thus the total amount is Rs. 750 Rs. 125 = Rs. 875.
3. The total number of shares including the fresh share should divide the total value, that is, Rs. 875. In other words, the average price has to be ascertained, that is Rs. 875/6 = Rs. 145.84.
The value of the right is calculated by deducting the average price from the market value of the share. In the instant case the value of right is Rs. 4.16 (i.e. Rs. 150 – Rs. 145.84).