Rights issues - risk to small shareholders

During the recent credit crisis, many listed companies are have rights issue to raise additional capital. The new shares are issued at a lower price than the existing shares. This will cause the existing shares to be diluted and the price to fall.

Here is an example. If the share price is $4, and new shares are being issued at $2 (on the basis of 1 new share for 1 old share), the share price is expected to drop to $3 after the new shares are issued. This is caused by "diluation".

The practice of rights issue has the following risk to small policyholders:

a) Difficulty in finding the additional money to take up the new shares. If you are offered to 10,000 new shares at $2, you have to find $20,000 to take up these shares. If you are not able to find this spare cash, you can sell the rights during a certain period.  In theory, the rights should be worth the expected drop in the price of the old shares.

b) Oversight. You may not be aware of the rights issue and you forget to take it up or to sell the rights. This will cause your investments to drop in value, as the avlue of the old shares would have dropped due to dilution. This oversight is easy to happen, as you may be busy with work or overseas, when the rights issue are announced.

At each rights issue, there will be a certain proportion of shareholders who fail to take up or selll the rights due to oversight. These investors lose out and the benefit is given to other shareholders who take up the new shares at the lower price. (In some companies, the directors take up these excess shares).

To avoid this risk, it is better for small investors to invest in a professionally managed fund, such as a ETF (exchange traded fund).  The professional managers will take care of the work of monitoring the investments, including collecting the dividends, subscribing to rights issues and other matters.