What are Right Shares? Objectives, Advantages, Disadvantages, Accounting Treatment

What are Right Shares?

Right shares means shares that are issued to the existing equity shareholders by virtue of their shareholders. Issue of right share means the issue of further shares by a company to its existing equity shareholders in proportion to the shares held by them in the company.

Section 62 of the Companies Act, 2013 makes it obligatory for companies regarding the further issue of shares to offer new shares to existing equity shareholders in the first instance. Further, the total number of shares should not be more than the authorized share capital of the company.

The existing equity shareholders enjoy a right to either subscribe to these shares or sell their rights or to reject the offer. In case the shareholder rejects the right shares the company can offer these shares to the public.


Objectives of Issue Of Right Shares

The main objectives of issue of right shares are:

  1. The objective of issue of right shares is to increase the subscribed capital of the company.

  2. Another objective of issue of right shares is to comply with the statutory provision of the Companies Act, 2013 on the issue of shares by an existing company.

  3. The popular objective of issue of right shares is to offer shares at a price lower than the market price to the existing shareholders.

Advantages of Issue of Right Shares

The advantages of issue of right shares are:

  1. One of the advantages of issue of right shares is that it leads to raise the subscribed capital of the company.

  2. Another advantage of issue of right shares is that it defuses the discontentment of the existing shareholders in regard to the expected benefits from the company.

Disadvantages of Issue of Right Shares

The disadvantages of issue of right shares are:

  1. Issue of right shares may encourage speculation in share market.

  2. The rate of return per share would decline because dividend would have to be paid on increased number of shares unless the profits increase considerably in future. It would have negative impact on the minds of the prospective investors.

  3. The company gets less money since right shares are offered at a price lower than the market price to the existing shareholders.

Accounting Treatment on Issue of Right Shares

The accounting procedure on the issue of right shares is the same. The problem lies, in this case, is in regard to the Valuation of Rights. Value of right means the value of the right of an existing shareholder to subscribe to further shares issued by the company.

It is the value of the benefit to be received by such shareholders when such rights are exercised. When expressed in monetary terms, it is the difference between the market price and the average price of shares.

For the valuation of rights, the following points are to be considered:

  1. Market price per share.

  2. Price of each Right share.

  3. Number of existing shares required to get one right share or the proportion of existing share and right share or the number of qualifying existing shares to get the specified number of right shares.

Example:

The following example will clarify the matter. The issued and subscribed share capital of Abanti Ltd. is Rs. 1,80,000 divided into 18,000 shares of Rs. 10 each.

The company issued right shares at Rs.15 per share to the existing shareholders in the proportion of 2 shares for every 9 shares held. The market price of each share is Rs. 35. Calculate the value of each right.

Solution:

Calculation of value of each right:

Value of each right = (Market price of one share – Average price of the total shares)

Market value of 9 shares @ Rs. 35 each = Rs. 315.00

Issue Price of 2 right shares @ Rs. 15 each = Rs. 30.00

Total = Rs. 345.00

Average price of (9 + 2) = 11 shares = Rs. 345.00 ÷11

= Rs. 31.36

Hence, Value of each Right = Rs. 35.00 – Rs. 31.36

= Rs. 3.64


Companies Act of Right Shares

The rights issue is governed by the Articles of Association and must be approved by an Ordinary Resolution of the members in a general meeting. The rights issue is offered to the shareholders in the same proportion as they hold shares in the company.

In case the company desires to offer shares to persons other than the existing shareholders, then it needs to pass a special resolution u/s. 81(1A). A private placement or a preferential allotment of shares would fall under this category. S.81(1) of the Companies Act does not apply to a private limited company.


SEBI Guidelines on Issue of Right Shares

The key requirements of the SEBI DIP Guidelines are as follows:

  1. The DIP Guidelines apply to all rights issues by listed companies except those where the aggregate value of the securities does not exceed Rs. 50 lakhs. However, in such cases the letter of offer must be prepared as per the SEBI disclosure requirements and file the same with the SEBI.

  2. The eligibility norms specified in the Guidelines for an initial public offer or a public issue do not apply to a rights issue.

  3. Pricing of a rights issue is free and as per the discretion of the company and the merchant bankers. In case of a public-cum-rights issue, the company can have a differential pricing for the two issues.

  4. The requirements of promoters contribution and lock-in period are not applicable in the case of a rights issue.

  5. Rights issues must be kept open for at least 30 days and not more than 60 days.

  6. The issuer company can utilise the funds collected from rights issue once the stock exchanges are satisfied that a minimum of 90% of the subscription has been received.

Difference between Bonus Shares and Right Shares

Bonus shares refer to the shares which are issued free of cost to their shareholders on a specified date by the companies. The bonus shares are issued at a certain proportion (eg. 1:1 or 2:1 or 3:1) according to the shareholders’ stake in the company.

The bonus shares are issued when the companies don’t want to disburse cash dividends to their shareholders, in such a scenario, they issue bonus shares to handle the liquidity crunch of their shareholders.

The bonus shares can also be issued if a company requires to decrease its share price in the market to make shares affordable to small investors. The bonus shares can also be issued in case of surplus reserves and the intention of the company is to expand its operations.

Due to the bonus issue, the share price of the company reduces and being affordable the demand for shares increases and thus the price of the share is also appreciated.

The Right Shares refers to those issues of shares that a company offers to their existing shareholders at a discounted price. The company’s shareholders have the right to accept or reject the proposal and also there are minimum criteria for subscriptions of the share if the shareholder accepts the proposal.

Such issuance of shares is called Right issues and such share is known as Right Shares.

The company notifies each shareholder regarding the issuance of the right share. The shareholders have to respond to the notice within a stipulated time period, however, they have the option to either subscribe fully or partially or avoid or can sell the offer as well in the market.

Difference between Bonus Shares and Right Shares

Basis of ComparisonRight SharesBonus Shares
MeaningRight shares are issued at a discounted prices to the existing shareholders and they have the option to agree or deny the offer.Bonus shares are issued free of cost to the shareholders in a certain ratio, other than a dividend.
PricesLess than the current market price.Free of cost.
PurposeTo raise quick and additional funds.To bring the share price down and as an alternative to the cash dividend.
SubscriptionMinimum subscription is mandatory.Not required.
Paid-up ValueFully or partially paid-up.Always fully paid-up.
Effect on Market Share PriceMay or may not decrease unless the shareholders sell off the shares.Always reduce based on an issued ratio.
Creation & RenunciationThese are additional shares created by the company and can be renounced partially or fully.These shares are created from the company’s profits, reserves & surplus and such a renunciation option is not available.

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