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Example research essay topic: Rights Issue Vs Seasoned Equity - 1,144 words

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RIGHTS ISSUE vs. SEASONED EQUITY ISSUE S. NO HEADING PAGE NO 1 WHAT IS A RIGHT ISSUE? 2 SEASONED EQUITY ISSUE 3 RIGHTS ISSUE vs. SEASONED EQUITY ISSUE 4 WHY DID THE SHARE PRICE DROP AFTER A RIGHT ISSUE 1. WHAT IS A RIGHT ISSUE? If an existing company which has already issued its shares through an IPO and listed in a stock exchange wants to issue new shares on the stock market mainly to raise funds, it has to make its offer to existing shareholders.

Thus, the existing shareholders get the first right or opportunity to buy the new shares offered by the company which is known as Rights issue. It is to be observed that the new shares are generally offered below the market price. For instance, if Royal and Sun Alliance, an Insurance company wants to raise? 790 m in a right issue and it is issuing shares at 65 p. When it made the announcement, they were trading at 115 Ap. Suppose, if they now stand at 100 Ap. Thus, the company is issuing 15 new shares for every 50 existing shares.

One of the disadvantages of the right issue is that when the new shares are issued, they usually dilute the value of the existing stock. The truth that shareholders can buy shares at a lower market price does not change this. For instance, if a company had 1 m shares trading at 100 p each and its total value or market capitalization, would be? 1 m. If the company then decided to issue 50, 000 new rights shares, the company would still have the same market capitalization. To reflect this and the increased number of shares, the share price should be expected to all to 95 p. A right option can be exercised by the relevant shareholder or they can sell their rights through a stock broker or through the company itself.

If a shareholder does not exercise his option, the company may sell his right share and the proceeds will be forwarded to the shareholder by the company. 2. SEASONED EQUITY ISSUE: A seasoned Equity issue is an issue of new securities from a well founded company whose existing shared has demonstrated stable price movements and mammoth trading volume, thereby earning good repute. These categories of shares have a high liquidity within the secondary market and this is known as Seasoned Equity Offering- SEO. Many investors prefer buying only seasoned issues instead of new issues that have not stood the test of time. These types of securities enjoy liquidity in the secondary market. Seasoned Equity will be much beneficial for companies which may raise capital for profitable NPV> 0 projects.

In certain cases, management may be of the view that companys stock may overvalued and to balance it, it may issue seasoned equity. For companies which is having too much leverage and find it difficult to service debt may opt for seasoned equity mainly to retire some debt. In case of certain regulated industries like gas, telephones, electricity companies may be instructed to fix their capital structure so as to have as part of the process of setting regulated product prices. Offering seasoned equity may help a company to weaken the control of outside stockholders. The findings of some of the previous empirical studies on the effect of seasoned equity are listed below: Masulis and Korea [ 1986 ] unearth that about 2. 5 % announcement effects for 424 issues.

Asquith and Mullins [ 1986 ] have examined 531 registered primary and secondary distributions for AMEX or NYSE listed stocks. 3. RIGHTS ISSUE vs. SEASONED EQUITY ISSUE: In U. K, under rights issue, existing shareholders is to subscribe on a pro rata basis and in effect, the rights issue policy was only practical floatation method for issuing seasoned equity.

But in U. S. A, there exist no pre emptive rights to existing shareholders and companies employ firm commitment offerings to raise seasoned equity. Further, the rights issue costs less than firm commitment offerings. [ Eckbo and Masulis (1992) ].

Due to high cost involved in rights issue, it is not favoured by U. S corporates as only less than 5 % of the equity issued by NYSE / AMEX companies during the period between 1960 and 1970. Further, it is observed that rights issue not only very costly but it is time consuming and reduced corporate flexibility. In case of seasoned equity issue, a merchant bank underwrites the shares on the spot and resells them to the client thereby infusing immediate liquidity to the company concerned.

A seasoned equity issue has the modest risk as the issue is typically priced just before it goes public and well after the initial pronouncement so that the secondary market offers an equipped apparent measure of post-announcement firm value. Under seasoned equity issue, the issuer has always the choice to pull out the issue from the market if the response in the market is injurious. 4. WHY DID THE SHARE PRICE DROP AFTER A RIGHT ISSUE? One of the reasons for the fall of share price after the right issue is due to the dilution of equity of a company. The increase in the number of shares of a company is going to achieve lesser dividend per share than before the right issue unless the profit of the company dramatically increases. The fall in value on announcement is not always the case and the price falls only on certain occasions.

For instance, Rao details Hanson's Paper a fall of approximately 5 % [ 1989 ] in Review of Financial Studies. But recent empirical studies have reported that the fall being less. For instance, Eckbo and Masulis find that there were negligible losses for non-underwritten right issues. For instance, after the announcement of rights issue of? 20 m by Densitron Technologies [a high-tech components distributor] its share value fell about 12 %.

The rights issue is mainly intended to fund the purchase of a 23 % stake in Vbest, a Taiwanese Liquid Crystal Display manufacturer. Densitron Technologies already owns about 2 % of equity of Vbest. With the proceeds of its proposed right issue, Densitron Technologies is planning to subscribe about 26 % of stake of Dbase. Densitron right issue will be on the basis of three new shares of every four shares held. The balance proceeds of the right issue left over after the acquisition of Vbest will be utilized for reduction of borrowings and to offer further working capital to Densitron. Illustration 2: INVENSYS PLC: Invensys PLC, a global competitor in production technology, solutions and services Invensys shares fell drastically due to gossip of a? 500 million right issue.

The shares fell a substantial 11 % to as low as 19 and a half pence when there was a talk of right issue in the market.


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