A rights issue is an issue of new shares which existing shareholders are offered in proportion to their current holding.
Rights issues are undertaken by companies who wish to raise capital. Companies often choose to do this when their debt to equity ratio has grown too high. The injection of fresh money increases company equity.
The new shares are often issued at a discount to the prevailing market price.
Shareholders may choose to subscribe to the rights issue or not. If they choose not to subscribe, their holding of the company will be diluted when the new shares are issued. For example, a shareholder might hold 1,000 shares of a company’s total of 1,000,000 shares. If the company undertakes a 1 for 1 rights issue and our shareholder opts not to buy any new shares, he will end up holding 1,000 shares out of a new total of 2,000,000 company shares. His ownership and voting rights in the company will have been halved.
Subscription rights to new shares may or may not be transferable. If the rights are transferable, the holder can opt to sell these rights on the open market to a buyer who wishes to take part in the rights issue.
Different degrees of new share issue are possible. One new share for every 10 existing shares would be a less significant rights issue, requiring a modest discount to the current share price, while one new share for every four existing would be be a significant issue, involving a greater discount in the price of the new shares.