Equity rights issues: theory and practice

Abstract

Two primary issues are examined ln this study. Firstly, which financial variables are associated with the success of a rights issue. The results suggested that the market capitalisation, rela­tive size of the issue and the return on capital employed were of importance. The statistical significance of the discount, measured as the difference between the current market price and the subscrip­ tion price and the importance of the pre-issue share price was difficult to explain. Secondly, a postal questionnaire (n = 110) was used to determine private shareholders' knowledge of rights issues with particular reference to the importance of the issue price. The respondents were randomly chosen from two public companies and the data did not exhibit a statistically significant difference between the two groups Over half of the respondents showed an ill-informed view and were classed as naive. The naive view was independent of the shareholders' characteristics. We have strong evidence to argue that the sample is representative of private shareholders as a population. The respondents' attitude towards the new issue was in accord with the perfect market model. Three supplementary topics were examined. A superior method to measure the discount offered in a rights issue showed that the subscription price chosen by a sample of the rights issues in 1976 was not inconsistent with that expected from perfect market theory. Theoretical evaluation of The Stock Exchange's procedure to adjust traded call option contracts when the underlying security is subject to a rights issue argued that an inconsistent method was used. The examination of the equilibrium between the direct and indirect routes of equity purchase during the subscription period of a rights issue produced re ults that were not inconsistent with the mooted option characteristic of a right.