What is rights issue and what are the advantages?

CPA-Financial-Management-Section-3 Revision kit

A rights issue is a method of raising new share capital by means of an offer to existing shareholders, inviting them to subscribe cash for new shares in proportion to their existing holding. It is by far the most important way in which new share capital is raised. A rights issue may be made by any type of company, private or public, listed or unlisted. The analysis below, however, applies primarily to listed companies.

The major advantages of a rights issue are:
(i) Under the Stock exchange regulations all issues of shares for cash other than rights issues must be approved by the company in general meeting. In contrast, subject to the Memorandum and Articles of Association, a rights issue may be made at the discretion of the directors. The Stock Exchange is therefore unlikely to accept any new issue of shares by a quoted company unless it is a rights issue, unless the purpose of the new issue is to allow a partial takeover by a large company or financial institution, which would be in the best interests of existing shareholders.
(ii) Rights issues are cheaper than issues to the general public. This is partly because no prospectus is required, partly because the administration is simpler and partly because the cost of underwriting will be less;

(iii) It is more beneficial to existing shareholders than an issue to the general public as it avoids expense represented by the discount on market value required on all issues. In effect, a rights issue secures the market discount for existing shareholders by ensuring that new shareholders cannot buy into the company at a price which is beneficial to them and, therefore, detrimental to the existing shareholders;
(iv) Relative voting rights are unaffected;
(v) As a method of issuing new equity, it provides a broader base for the company, which will make future borrowing by the company relatively easier.

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