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1. When a shareholder does nothing but all the other shareholders exercise their rights or sell them, does it mean that the shareholders will lose nothing at all since the company will sell the rights to new subscribers for the benefit of the shareholders?
2. If the company sell the rights to new subscribers on the behalf of the shareholders, does it mean that the number of shares held of the shareholder who does not exercise his rights will increase by the number of rights issue that he is entitled to?
3. If that’s the case, why would a shareholder bother exercising the rights if he will not lose his wealth even if he does not do anything?
as far as i know, the rules vary in different contries.
for a developing country or security market, it more likely that the right is not able to be traded apartly, current holder has options to take the right or ignore it, but cannot sell the right.
since right issue is at discount, ignorance is a bad idea financially, meanwhile for any reason, shareholder may have no willingness or capability to invest more money, the alternative option is to sell out all stocks… and maybe buy back at or after the ex-right date for ex-right price. in this situation, he/she actually lose nothing but transaction cost.
for a developed country or market, shareholder have one more option, to sell the right only. the only reason to ignore such right issue is forget or simply missed the announcement.
in any circumstances, do nothing must make a paper loss.
i have no idea how company can exercise rights on behalf of shareholders and benefit them.Because when I read from the study text, it says that if the shareholders does nothing, the company will well the rights to new subscribers for the benefit of the shareholders. That’s why I’m a bit confused about that.
Why would a shareholder want to sell out all his stocks and buy it back later at the ex rights price? Will the shareholder benefit by doing that?
@Jenn
although my study text doesn’t state such circumstances, i looked for it on internet, you’re right there’s such mechanism in some market.
i have no idea how it works, but it might be enough to understand it literally.if rights itself can be traded alone, regardless of who trade it, assume original cost equals to cum-right price, shareholders have 4 options:
A) take all rights…… it requires more cash to invest in, share number increases, cost per share equals to ex-right price, no cash retained, MV increased since more cash invested, no loss
B) take part of rights and sell the rest…… situation varies, in a special situation, investor can find out a middle point where proceed of selling right equals to cost of taking right, then it requires no extra cash, share number increases, cost per share equals to ex-right price, no cash retained, MV no change, no loss
C) sell all rights…… it requires no extra cash, share numbers no change, cost per share equals to cum-right price, cash obtained and retained, cash+new MV = MV before right issue, no loss
D) give up rights…… it requires no extra cash, share numbers no change, cost per share equals to cum-right price, no cash retained, MV is lowered, suffer a loss PS: the less rights given up, the less loss sufferedif rights itself cannot be traded alone, to sell and buy back is the only way to avoid loss where no more cash is available to be invested in.
All of Jenn’s original 3 questions are dealt with in my free lecture on here!
1 Regardless of what might be the law in different countries, for Paper F9 (for quoted companies) the rights themselves are traded and so the shareholder has the choice of taking up the rights or selling them. In F9 you are asked both for the theoretical ex-rights share price and also for the value of the rights. (In practice in the UK, a quoted company will automatically sell the rights for you if you do nothing, but that is not relevant for the exam).
2 If a shareholder sells the rights, then the number of shares he/she owns will not change. They only have more shares if they take up the rights! (The person who bought the rights will take up the new shares)
3 In theory, the overall wealth of the shareholder will remain the same whether or not they take up the rights. Either they take up the rights – in which case they have more shares, the value of each share is lower, but the total value of their shares will be the same.
If they sell the rights, then they do not have more shares so the total value of their shares will be lower, but they have more cash (from selling the rights). This is illustrated in full in my lecture.However, two things are relevant in practice: firstly the new share price is likely to be higher than the theoretical ex-right price (because usually shareholders will be expecting the company to invest the money they raise well).
Secondly, if they sell the rights then their shareholding is worth less, but they have more cash – it depends what they intend to do with the cash. Taking up the rights is effectively investing more in the company, which they might well prefer to do.What is very common in practice is for shareholders to take up some of the rights and sell the rest – in this way they are able to maintain the total value of their shares with no net affect on their cash balance (again, I illustrate this in my free lecture).
After a rights issue, the share price would fall. But I read that there would be no effect on shareholder wealth. Why is that so? If the share price drop, doesn’t it mean that the capital gain decreases too?
In theory there is no effect on the shareholders wealth.
The share price does fall, but shareholders own more shares and so their overall (total) wealth remains the same.
You really should watch the free lecture about it on here – dealing with rights issues is a common topic in the exam.
Please watch the free lectures. you will better understand rights through calculation than using words. sounds so complicated with words but very simple mathematically!!
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