If you are a premium customer of some business and is purchasing goods from same shop or business for a long period of time than as a premium customer you get privileges in the form of additional discounts, early bird offers, privileged treatment and so on. In the same way in case of stock markets companies reward their loyal shareholders by offering them shares of the company at a discounted price to the current market price for a limited time period. In order to understand more about the rights issue one should look at the advantages and disadvantages of the rights issue –
Advantages of Rights Issue
Economical for Company
As far as issuing company is concerned they find it economical to raise capital through rights issue route rather than raising capital through initial public offering because initial public offering involves many costs which can be saved if the company is choosing the right issues route for raising capital.
Increased Confidence of Shareholders
Another benefit of right issue is that just like when as a consumer you get extra satisfaction due to you getting privileged treatment from companies in the same way as a shareholder when you get shares at discounted price you get satisfaction and joy which leads to greater confidence in the company and as far as company is concerned that confidence of shareholders can come in handy in future.
No Compulsion
Rights issue as the name suggests give rights to current shareholders and there is no compulsion to subscribe to the offering of the company. In simple words, it gives flexibility to the shareholders to either subscribe to rights issue or let go the rights issue by not participating in the right issue of the company.
Disadvantages of Rights Issue
Inappropriate Use of Funds
While many companies use the funds raised from rights issue for growth and expansion plans but there is another side of the coin too and that is many companies use funds raised from rights issue for window dressing their balance sheet. In simple words, some companies misuse the funds raised through this route which ultimately has an adverse effect on the share price and shareholders of the company.
No Guarantee of Profits
There is a time lag between the announcement of the rights issue by the company and shareholders getting shares in their trading account and if in that period share price of the company falls than there is no use of rights issue as far as the shareholder is concerned. Hence, for example, suppose the stock price of Amazon is $200 and company comes with the right issue at $180 but after the announcement share price of Amazon goes to $180 or below $180 than shareholders do not get any benefit from the right issue.
Dilution of Shareholders Stake
If the shareholder does not subscribe to the right issue than it will lead to dilution of shareholders stake because after the rights issue the stock price trades at ex-rights price and if shareholder does not wants to dilute his or her stake than he or she should subscribe to rights issue if he or she does not want to dilute his or her stake in the company.
As one can see from the above that rights issue has advantages and disadvantages and that is the reason why a company should carefully analyze above points and the take the decision whether to go for the rights issue or not.