When a company needs to raise capital, it has several options: issuing bonds, taking loans, or selling new shares. A rights issue is a specific method of selling new shares that gives existing shareholders the first opportunity to buy them, usually at a discount.
For investors holding US stocks, understanding how rights issues work helps you make informed decisions when one is announced for a company in your portfolio.
What Is a Rights Issue?
A rights issue is a fundraising method where a company offers existing shareholders the right to purchase additional shares in proportion to their current holdings, typically at a price below market value.
If you own 100 shares and the company announces a 1-for-5 rights issue, you receive the right to buy 20 additional shares at the discounted offer price. These rights are distributed to all shareholders of record on a specific date.
Companies use rights issues to fund acquisitions, reduce debt, finance expansion, or strengthen the balance sheet. Unlike a public offering that sells shares to anyone, a rights issue gives existing shareholders the chance to maintain their ownership percentage first.
How Rights Issues Work
The process follows a structured timeline from announcement to completion.
Announcement and terms
The company announces the ratio (such as 1-for-4), the subscription price, the record date, and the exercise deadline. The subscription price is set below the current market price to incentivize participation, typically at a 15% to 30% discount.
Record date and distribution
Shareholders who own stock on the record date receive rights proportional to their holdings. These rights function like short-term options, giving holders the ability to buy new shares at the fixed subscription price within a two-to-four-week window.
Exercise or trade
Shareholders can exercise their rights by paying the subscription price, sell the rights on the open market if tradeable, or let them expire. Each choice carries different implications for ownership and portfolio positioning.
Dilution and Rights
Dilution is the central concern in any rights issue. When a company creates new shares, each existing share's ownership percentage decreases unless the shareholder participates.
Consider a company with 10 million shares outstanding. A 1-for-4 rights offering creates 2.5 million new shares, bringing the total to 12.5 million. A shareholder who owned 1% before now owns 0.8% if they do not participate.
Earnings per share also dilute. The same earnings spread across more shares mean lower EPS, which can pressure the stock price. This is why the market often reacts negatively to rights issue announcements.
However, dilution is not automatically harmful. If the capital raised generates returns above the company's cost of equity, the value created can offset the dilution. A rights issue funding a high-return acquisition or eliminating expensive debt can ultimately benefit shareholders.
Participating vs Selling Rights
When a rights issue is announced, shareholders face a decision with meaningful financial consequences.
Exercising the rights
Participating means paying the subscription price to acquire additional shares, maintaining your ownership percentage at the discounted price.
This makes the most sense when you believe in the company's long-term prospects and the reason for raising capital is sound, such as funding growth or strengthening its financial position.
Selling the rights
If tradeable, shareholders can sell their rights on the open market. This generates immediate cash but means accepting dilution. Selling makes sense when you lack capital to participate, want to reduce exposure, or believe the market is overvaluing the rights relative to the company's outlook.
Letting rights expire
Doing nothing is the worst outcome. The shareholder experiences full dilution without compensation. Even shareholders who want to reduce their position are better off selling the rights than allowing them to lapse.
Rights Issue Impact
Rights issues affect stock prices, company fundamentals, and market sentiment in ways that extend beyond the mechanics of dilution.
Share price adjustment
After a rights issue, the stock price typically adjusts downward to reflect dilution and the discounted subscription price.
The theoretical ex-rights price (TERP) combines the market value of existing shares with new shares raised, divided by total share count. Actual prices may differ based on sentiment.
Signal to the market
Why the company needs capital matters more than the mechanics. A rights issue funding an acquisition is viewed differently than one covering operating losses or repaying maturing debt.
Capital raised out of financial necessity rather than strategic opportunity draws harsher market reactions.
Impact on key ratios
Beyond EPS dilution, rights issues affect book value per share, return on equity, and debt-to-equity ratios.
If proceeds reduce debt, leverage improves even as per-share metrics dilute. Evaluating the net effect requires the complete picture.
Conclusion
Rights issues are a fundamental corporate action that directly affects shareholder value. Understanding the mechanics of dilution, the trade-offs between exercising and selling rights, and the broader impact on company fundamentals helps investors respond rationally rather than reactively.
The key question is always whether the capital raised will create enough value to justify the dilution. Companies that invest proceeds wisely can emerge stronger despite the short-term pressure on share price and per-share metrics.
FAQ
What is a rights issue?
A rights issue is when a company offers existing shareholders the chance to buy additional shares at a discount, proportional to their current holdings.
Does a rights issue dilute shareholders?
Yes, unless shareholders exercise their rights to maintain their ownership percentage. Non-participating shareholders see their proportional stake decrease.
Should I always exercise my rights?
Not necessarily. The decision depends on the company's reason for raising capital, your conviction in its prospects, and whether you have available funds to participate.
References
- Investopedia, Understanding Rights Issues, 2026.
- Zerodha, What is a Rights issue?, 2026.
