What it means
The structure is described as a ratio, such as one-for-four, meaning a shareholder can buy one new share for every four already held. The subscription price sits below the current market price to make the offer attractive and to give a cushion in case the share price drifts down before the offer closes.
That discount is not free money, because the extra shares dilute the value of every existing share. Companies choose rights issues for two reasons: fairness and control.
Existing shareholders get first refusal, so no one is diluted against their will provided they have the cash to participate, and the company avoids handing a large block to a new investor who might want board representation. The trade-off is that rights issues are slow, expensive to administer and read by the market as a sign that money is needed.
The key concept for anyone reading the announcement is the theoretical ex-rights price, or TERP. It is the weighted average of the old shares at the market price and the new shares at the subscription price, and it estimates where the share price should settle once the new shares exist.
The share price falling towards TERP on the day is arithmetic, not a market verdict on the company. The value of a right is the difference between TERP and the subscription price, which is what a shareholder who does not want to participate can sell for.
In a nil-paid rights market these rights trade separately for a short window, so doing nothing at all is usually the worst of the three available choices. A shareholder who ignores the letter simply loses that value.
The market reads the purpose closely, and the reaction depends far more on the use of proceeds than on the discount. Money raised to fund a specific acquisition or a plant with a stated return tends to be received calmly, while money raised to repay debt after a covenant breach is received badly.
A deeply discounted issue, sometimes 30% or more below market, generally signals urgency.
In practice
Real-world examples.
Example
A regional airline raises $200,000,000 through a two-for-five rights issue at a 25% discount to fund an order for fuel-efficient aircraft. Institutional holders take up their entitlement in full because the fleet economics are clearly set out in the prospectus.
Example
A property group announces a deeply discounted rights issue after breaching a loan-to-value covenant. The share price falls further than the arithmetic of TERP would suggest, because the market reads the raise as a rescue rather than an investment.
Example
A retail investor holding 4,000 shares receives a one-for-four entitlement to 1,000 new shares but cannot fund the $5,000 required. He sells his nil-paid rights on the market for roughly $2,400 instead of letting them lapse, recovering the value of the dilution in cash.
Think of it
“Rights issue lets current shareholders buy new shares first-protection against dilution.
Formula
Calculation
TERP = (Existing shares x Market price + New shares x Subscription price) / Total shares after the issue. Value of one right = TERP - Subscription price.
A company has 10,000,000 shares trading at $8.00, giving a market value of $80,000,000. It announces a one-for-four rights issue at a subscription price of $5.00, so it issues 10,000,000 / 4 = 2,500,000 new shares and raises 2,500,000 x $5.00 = $12,500,000.
Total value afterwards is $80,000,000 + $12,500,000 = $92,500,000 across 12,500,000 shares, so TERP = $92,500,000 / 12,500,000 = $7.40. The value of the right to buy one new share is $7.40 - $5.00 = $2.40, and since it takes four existing shares to earn one right, the value attaching to each existing share is $2.40 / 4 = $0.60. That is exactly the drop from $8.00 to $7.40, which is why a shareholder who takes up the offer in full is no worse off.Case study
Seen in the real world.
This is an illustrative and entirely fictional example. Larkfield Ceramics, an invented listed manufacturer, needed $12,500,000 to buy a competitor's kiln facility that had come up unexpectedly. With 10,000,000 shares in issue at $8.00, the board chose a one-for-four rights issue priced at $5.00 rather than a private placement to a single institution, precisely because a large placement would have handed one investor a board seat.
The announcement came with a two-page explanation of the acquisition economics: the kiln would add capacity worth roughly $3,000,000 of annual gross profit, and the board expected the purchase to pay for itself within five years. The share price fell from $8.00 to close near $7.40 on the day, which the financial press correctly reported as the theoretical adjustment rather than a sell-off.
Take-up reached 94%, and the underwriters placed the small remainder in the market. In this fictional account, the useful lesson was communication: because Larkfield explained TERP in the shareholder letter, its investor relations team spent the following week discussing the acquisition rather than fielding calls from retail holders who thought the shares had crashed.
Watch out
Common mistakes.
- Reading the post-announcement share price fall as a loss of value, when most of the drop is the arithmetic adjustment to the theoretical ex-rights price.
- Ignoring the offer letter entirely, which forfeits the tradeable value of the rights and dilutes the holding for nothing in return.
- Treating the discount as a bargain, when the discount is offset by dilution and only benefits shareholders who actually take up their entitlement.
Questions
People also ask.
What happens if I do nothing?
Your stake is diluted and, depending on the terms, any residual value from unexercised rights may be sold on your behalf or simply lost.
Why not just issue shares to a new investor instead?
A placement is faster and cheaper, but it dilutes existing holders without giving them a choice and can shift control towards a single new party.
Is an underwritten rights issue safer for the company?
Yes, because underwriters agree to buy any shares that shareholders do not take up, guaranteeing the proceeds in exchange for a fee.
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