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Script:

Harvey (Mr.Young) : Could you explain to me in detail what a rights issue is?

Morris: A rights issue is an issue of new shares for cash to existing shareholders. The shares are issued proportionally, that is, in proportion to the number of shares the shareholders already hold. It’s a good way of raising new cash from shareholders. For publicly quoted companies, it’s a source of new equity funding.

Harvey: But why issue shares to existing shareholders?

Morris: From a legal standpoint, a rights issue must be made before making a new issue to the public, and the existing shareholders have what is referred to as the 'right of first refusal’ on the newly issued shares. This right is also known as a 'pre-emption right’. Why is this important for the shareholder? Well, when a shareholder takes up these pre-emption rights, he can maintain his existing percentage holding in the company. However, shareholders sometimes waive these rights and sell them to others.

Harey: What about the price of these shares?

Morris: The price at which the new shares are issued is generally much lower than the market price for the shares. You often see discounts of up to 20 or 30 per cent.

Harvey: That doesn't really make sense to me. Why would a business offer new shares at a price that's significantly lower than the current market price of the shares?

Morris: The main reason is to make the offer attractive to shareholders. Also, the aim is to encourage the shareholders either to take up their rights or sell them. The idea behind this is to ensure that the share issue is fully subscribed. That means, of course, that the new shares have all been sold. The price discount has another function, too: it serves as a kind of safeguard if the market price of the company's shares falls before the issue is completed. It makes sense if you think about it: if the market share price fell below the rights issue price, then it would be very unlikely that the issue would be successful. Naturally, in such a case, shareholders could buy the shares more cheaply on the stock market than by taking up their rights to buy through the new issue.

Harvey: So, let me see if I understand you correctly. You said that existing shareholders don't have to take up their rights to buy new shares, is that right?

Morris: That's right. Shareholders who don’t want to take up their rights are entitled to sell them on the stock market or by way of the company making the rights issue, either to other existing shareholders or new shareholders. In that case, the buyer has the right to take up the shares on the same basis as the seller.

Harvey: Are there any other matters connected to rights issues that I should know about?

Morris: Just one more thing, perhaps - shareholder reactions. Shareholders may be unhappy about firms continually making rights issues and may have a negative reaction. They may not like being forced to do something - and rights issues force them either to take up their rights or sell them. As a result, they may sell their shares. And selling their shares can drive down the market price.