A Right Issue of Shares is a method by which a company raises fresh equity capital by offering new shares to its existing shareholders in proportion to their current holdings, generally at a price lower than the prevailing market rate. This approach is based on the principle of pre-emptive rights, which gives existing shareholders the first opportunity to invest further in the company before shares are offered to external investors. By doing so, companies can raise funds while allowing shareholders to maintain their ownership percentage if they choose to subscribe to the offer.

Unlike bonus shares or stock splits, a rights issue leads to an actual inflow of money into the company. The funds raised can be used for business expansion, repayment of debt, working capital requirements, or strengthening the overall financial position. While shareholders who do not participate may face dilution, rights issues are generally considered a balanced and shareholder-friendly fundraising option, as they combine capital generation with transparency and protection of existing ownership interests.

In this article, CA Manish Mishra talks about Right Issue of Shares: When and Why Companies Choose It.

Concept and economic rationale of a rights issue

The fundamental principle of a rights issue is pre-emptive right, which allows existing shareholders to maintain their proportionate ownership before shares are offered to outsiders. Companies typically opt for a rights issue when they require capital for business expansion, debt reduction, working capital needs, acquisitions, or regulatory capital requirements. Since shares are offered first to existing shareholders, a rights issue is often perceived as a shareholder-friendly method of fundraising compared to preferential allotments or public issues.

From an economic standpoint, the rights issue price is generally set below the market price to encourage subscription. Once the issue is announced, the market price of the shares usually adjusts downward to reflect the increase in share capital and the discounted issue price. This adjustment is mathematical and does not necessarily indicate deterioration in business fundamentals.

Financial impact on shareholders and ownership structure

A rights issue increases the total number of shares outstanding and brings additional capital into the company. Shareholders who subscribe to their entitlement maintain their ownership percentage, while those who renounce or do not subscribe may face dilution. The value of a shareholder’s investment post-issue depends on whether they exercise their rights, sell them (if renunciation is allowed), or ignore them altogether.

Rights issues also affect earnings per share (EPS). Since the share count increases, EPS may reduce in the short term unless the funds raised generate incremental earnings. However, if the capital is deployed efficiently, the long-term impact on EPS and shareholder value can be positive.

Legal framework governing rights issue under Indian law

Rights issues are governed primarily by Section 62(1)(a) of the Companies Act, 2013, which mandates that further issue of shares must first be offered to existing shareholders in proportion to their paid-up capital. The law specifies the manner of offer, notice period, pricing, and acceptance or renunciation of rights. The Articles of Association must authorize the issue of further shares; otherwise, they must be amended before proceeding.

The offer must remain open for a minimum statutory period, allowing shareholders sufficient time to decide whether to subscribe, renounce, or decline the offer. The law also recognizes renunciation rights, enabling shareholders to transfer their entitlement to others, subject to the terms of the offer.

Corporate approvals and procedural compliance

The rights issue process begins with board approval, where the terms of the issue size, ratio, price, record date, and offer period are finalized. In certain cases, shareholder approval may be required depending on the Articles or specific regulatory conditions. After approval, the company issues a letter of offer to eligible shareholders, detailing the terms and procedure.

Upon closure of the issue, the company allots shares to subscribers, updates statutory registers, issues share certificates or credits shares in demat form and completes applicable regulatory filings. For listed companies, additional disclosures and exchange compliances apply throughout the process.

SEBI compliance for listed companies

For listed companies, rights issues are subject to SEBI regulations governing disclosure, pricing, timelines, and investor protection. Companies must ensure transparent communication, timely disclosures to stock exchanges, and adherence to prescribed timelines for record date, issue opening, issue closing, and allotment. SEBI’s regulatory framework aims to ensure fairness, prevent insider advantage, and protect minority shareholders during capital-raising exercises.

Listed rights issues also involve coordination with registrars, stock exchanges, and depositories to manage entitlement trading (where applicable), renunciation, and demat credit efficiently.

Accounting treatment and impact on financial statements

From an accounting perspective, a rights issue results in an increase in paid-up share capital and share premium (if shares are issued above face value). The cash received strengthens the company’s balance sheet and improves liquidity ratios. Unlike bonus issues, reserves are not capitalized; instead, equity increases through fresh inflow.

The use of proceeds must be disclosed clearly, and auditors closely examine whether funds raised through a rights issue are deployed in line with stated objectives. Misuse or diversion of funds can raise governance and regulatory concerns.

Tax implications for shareholders

For shareholders, the tax impact of a rights issue depends on how the entitlement is handled. If shareholders subscribe to the rights issue, the cost of acquisition of the new shares is the issue price paid, and the holding period begins from the date of allotment. If shareholders renounce their rights for consideration, the amount received may be taxable as capital gains, subject to applicable provisions and holding period rules.

Proper documentation of offer letters, allotment advice, and transaction records is essential for accurate tax reporting and compliance.

Strategic considerations: When companies prefer a rights issue

Companies generally prefer a rights issue when they want to raise capital without increasing debt, avoid interest burden, and minimize dilution by giving existing shareholders the first opportunity to invest. It is often chosen during periods of market volatility, when public issues may be risky, or when promoters want to reinforce confidence by committing to subscribe to their entitlement.

Rights issues are also commonly used to repair stressed balance sheets, meet regulatory capital norms, or fund turnaround strategies. However, repeated rights issues without clear value creation can raise concerns about financial health and capital efficiency.

Governance risks and common compliance challenges

Governance risks and compliance challenges are a critical aspect of rights issues and often determine how the market perceives such fundraising exercises. One of the primary risks arises from improper or aggressive pricing of the rights issue. If the issue price is set too low without adequate justification, it may unfairly advantage certain shareholders, particularly promoters, and raise questions about whether the pricing truly reflects the company’s valuation and funding needs. Similarly, inadequate or unclear disclosures regarding the purpose of the issue, use of funds, and financial position of the company can undermine transparency and expose the company to regulatory scrutiny.

Another major challenge is non-compliance with statutory timelines and procedural requirements, such as delays in issuing offer letters, allotment of shares, or regulatory filings. Such lapses can erode investor confidence and invite regulatory action. Governance concerns may also arise when promoters subscribe disproportionately to the rights issue while public shareholders do not, leading to increased ownership concentration and potential control imbalance. To mitigate these risks, companies must ensure equal treatment of all shareholders, maintain clear and timely communication, adopt fair pricing mechanisms, and provide a detailed and credible explanation of how the funds raised will be utilized to create long-term value.

Conclusion

A rights issue of shares serves as a balanced and strategic method for companies to raise fresh capital while safeguarding the interests of existing shareholders. By offering shares in proportion to current holdings, it allows shareholders to retain their ownership stake if they choose to participate, while providing the company with much-needed funds to support expansion, reduce debt, or strengthen working capital. Although shareholders who do not subscribe may experience dilution, the structure of a rights issue ensures fairness by giving all eligible shareholders an equal opportunity to invest before shares are offered to others.

The overall success of a rights issue depends largely on effective execution and strong governance. Strict compliance with legal and regulatory requirements, transparent and timely disclosures, and fair pricing are essential to maintain investor confidence. Equally important is the efficient and accountable use of the funds raised. When a rights issue is well-planned and aligned with long-term business objectives, it can reinforce financial stability, improve market perception, and contribute positively to sustained shareholder value and corporate growth.

Frequently Asked Questions (FAQs)

Q1. What is a Right Issue of Shares?

Ans. A right issue is a method of raising capital where a company offers new shares to its existing shareholders in proportion to their current shareholding, usually at a discounted price. It allows shareholders to maintain their ownership percentage in the company.

Q2. Why do companies prefer a rights issue over other fundraising methods?

Ans. Companies choose a rights issue to raise funds without increasing debt or offering shares to external investors first. It helps strengthen the balance sheet while giving existing shareholders a priority opportunity to invest.

Q3. Does a rights issue dilute shareholding?

Ans. A rights issue does not dilute shareholding if shareholders subscribe to their entitled shares. Dilution occurs only when shareholders choose not to participate or renounce their rights.

Q4. Is it mandatory for shareholders to subscribe to a rights issue?

Ans. No, subscribing to a rights issue is optional. Shareholders may subscribe, renounce their rights in favor of others (if allowed), or ignore the offer. However, non-participation may lead to dilution.

Q5. How is the rights issue price determined?

Ans. The issue price is decided by the company’s board and is usually set below the prevailing market price to encourage shareholder participation. Pricing must be fair and transparently disclosed.

Q6. Can shareholders sell or transfer their rights?

Ans. Yes, shareholders can renounce or transfer their rights to another person, subject to the terms of the offer. This is particularly common in listed companies where rights entitlements may be tradable.

Q7. How does a rights issue affect the share price?

Ans. After the announcement of a rights issue, the market price of the shares usually adjusts downward to reflect the increased number of shares and the discounted issue price. This adjustment is technical and not necessarily negative.

Q8. What is the impact of a rights issue on EPS?

Ans. Since a rights issue increases the number of outstanding shares, Earnings Per Share (EPS) may decrease initially unless the funds raised generate additional profits. Long-term EPS depends on how effectively the capital is used.

Q9. What approvals are required for a rights issue?

Ans. A rights issue typically requires board approval and may require shareholder approval depending on the company’s Articles of Association and applicable legal provisions. Listed companies must also comply with stock exchange and SEBI requirements.

Q10. Are rights issues applicable to unlisted companies?

Ans. Yes, both listed and unlisted companies can issue shares through a rights issue, provided they comply with the Companies Act, 2013, and their Articles of Association.