RIGHT Answer

A mundane topic turned interesting all of a sudden today when understanding Rights Issue sparked up a thought. In October 2008, three of the biggest names of Corporate India came out with a rights issue especially when the markets were not doing well. So were they stupid? I don’t think so. If one were to think that people running multimillion dollar businesses came out with a Rights Issue just because they needed the money, then probably one might be underestimating their expertise a little too much.
Investopedia defines Rights Issue as “Issuing rights to a company's existing shareholders to buy a proportional number of additional securities at a given price (usually at a discount) within a fixed period”.

So why did the companies come out with a rights issue despite knowing that the chances of it being a failure was very high. These aren’t your average mom n pop companies. We are talking about names such as Tata Motors and Chettinad Cements.

Rights issues are issues at a discount and this theoretically acts as an incentive for existing shareholders to buy the shares. But when times are bad and the markets are not doing well, investors might prefer staying away from additional investment in the markets and as a consequence not subscribe to the rights option they have. This in turn sends a bad signal to the market when existing shareholders are not willing to buy a stock and the stock might be sold as a result. So then why take the risk?

A rights issue tends to cost the company far less than a Follow On Public Offer and also gives the company an opportunity to test the pulse of the market. Companies also understand that existing investors work partly on emotion when buying the stock, especially when it has given them stable returns over a period of time. Even if the rights issue fails, it helps the company prevent the irreparable damage done from a failed FPO.

So if the company is planning to come out with an FPO in an year’s time or so and if the markets are not doing well, companies tend to go for a Rights Offer to gauge the market and accordingly plan for the FPO. This is the reason why one would see that companies with failed Rights Issues tend to come up with an FPO within the following 15 months.