Share Placement and Rights Issues: What is the Role of Investor Education?

Categories: Asia Pacific, Corporate Governance, Standards, Ethics & Regulations (SER)
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Judging from the Facebook activity around the newly launched CFA Institute report Non-Preemptive Share Issues in Asia: Role of Regulation in Investor Protection, it is relatively safe to conclude that interest — or rather a lack of knowledge about share placement and non-preemptive share issues — are respectively strong and rampant. If you do not fully understand the concept of share placement and its twin sister — rights issues — rest assured that you are not alone.

On a personal note, my maiden encounter with share placement and rights issues dates back nine years. It involved a dot-com company whose stock price reached an all-time high during the 1999–2000 Internet bubble, and later crashed to less than 10% of its IPO pricing. (A fantastic story from an interesting era for another day; for now, let’s get back to the main story.)

The market share price of that company was 53 cents. Concurrently, there was a one-for-four rights issue, with each issue priced at 16 cents each. Being a minority shareholder and having some spare cash at hand, I dutifully applied for my allotment at the ATM machine. While navigating through the menu, I came across an option called “excess rights issue subscription.” Out of curiosity, I clicked it. Up came a long narrative list that roughly explained that this option allowed one to bid for any right issues that were not taken up by existing shareholders. Given the steep discount from the then-current market share price, there was only a small probability that the post-rights issue share price would go underwater within the window period — barring, of course, a dramatic corporate or catastrophic event.

I applied for the “excess rights” and was subsequently filled at 20%, a much higher figure than the usual fulfillment rate for even IPO issues. The share price remained fairly constant during the first day of post-rights-issue trading. I immediately cashed in all my shareholdings and was handsomely rewarded a return of more than 200% on a per-annum basis for the entire episode. Not too bad for an undergraduate student.

Besides feeling very happy for my lucky streak, I began to wonder how it all happened. And why are there so many “excess rights” floating around? At such a steep discount, who in their right mind would give them up?

To answer the above questions, I have developed the following theories:

  1. Some investors might have changed their mailing address and forgotten they owned the shares.
  2. Investors wanted to invest but did not have the spare cash to do so.
  3. Investors received physical mailings that informed them of the pending rights issue, but they had no clue what it was all about and chose to ignore it.

The first scenario is plausible but relatively unlikely; very few investors would forget about the stock they own, and among this small group, even fewer would have lost their mailing contacts with the stock exchange. Let’s move on to the second scenario.

At first glance, the second scenario sounds intuitively logical given that it is quite common for people to be short on cash from time to time. But at such a steep discount, it makes no sense to ignore the rights issue. This group of investors could either borrow from friends and relatives or receive margin financing from their stockbrokers.

Indeed, the third scenario would most likely explain the bulk of the “excess rights.” It is quite natural for humans to refrain from taking any action when faced with ambiguity; they want to prevent behavior they may later regret. For companies who dish out a normal rights issue, there is at least a first right of refusal given to all existing shareholders. What would be more contentious would be a private placement to outside investors that directly dilutes the value of all existing shareholders, and more so when the issue price is way below the current market share price.

Is there anything in regulation that could potentially limit management from indefinitely dishing out private placements? It varies by jurisdiction. Some do and others do not.

Some jurisdictions have safety features in place, including:

  1. No dilution of share value beyond that of par value; the par value of a share is typically very low, so this safety feature is not really useful at all in practice.
  2. Prior to issuance of private placement, top management must gain approval from the majority of the shareholders; what differs among jurisdictions is the required percentage threshold.
  3. During the special general meeting with shareholders, top management must substantiate the proposed share placement based on concrete reasons.

But even when such safety features are in place, top management can still seek shareholder approval to grant them the pre-emptive right to dish out private-share placements. In other words, top management can appeal to shareholders to give up their entitlement to the last two safety features mentioned above.

The reason top management may give for doing so often revolves around the need for flexibility in fund raising to improve their responsiveness towards profitable investment opportunities. We are not here to argue the validity of this statement. However, we need to highlight that when shareholders surrender these rights, there are very few mechanisms to keep check on potential share-dilution corporate activities.

During the voting process, minority investors typically refrain from taking any action; again, most probably do so because they do not understand what is being voted on. Add to that the presence of a majority shareholder who (for some reason) is highly favorable of the change, and it becomes relatively easy for the motion to get approved among those who voted.

In order for the current situation to improve, it might eventually boil down to appropriate investor education. Unfortunately, most investor education forums nowadays revolve around a panel of experts to voice their opinions on where the market is heading or what stocks to buy. That is not what we are looking at.

Rather, appropriate investor education should be a genuine attempt to empower stakeholders with the right knowledge and tools so that the capital market has enough depth to be truly caveat emptor (or “buyer beware”). But given the typical preference towards short-term punting and lack of tenacity to gain investing knowledge among the general public, it will definitely be a hard nut to crack in practice.

I will be looking at the appropriate types of investor education in my next blog post. Please stay tuned.


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Photo credit: iStockphoto.com/erhui1979

6 comments on “Share Placement and Rights Issues: What is the Role of Investor Education?

  1. Eric said:

    Interesting. Would like to know further how this investor education can be put into real practice especially to general public/ minority investors given that most of them will have no clue on what share placement and right issues are all about. And if this really can be done, what would be the impact on the minority investors and the company?

  2. Alan Lok, CFA said:

    Eric, thanks for your kind comments. I have the intention to write a few more articles detailing my thoughts on the important components of investor education. Following that, I will analyze in detail some interesting facts in relation to market irregularities as well as regulatory issues. No overnight magic or silver bullet. Indeed, it may take a few generations before the effect of investor education on retail investors eventually takes shape. During the process, though, it will be interesting. Stay tuned and I shall look forward to all your future comments.

  3. Joshua said:

    Thanks for sharing Alan – Indeed investor education is very much neglected in the obsession to pick the “best stocks” in the market with many learning the hard way that it is critical to at least have some basic knowledge to survive in the long run. Since we are on the topic of rights and placements – could you share which of the two is a better way for the company to raise money and why? ( Read somewhere that companies normally go for placements first if they can get it since it is a cheaper alternative although as a retail investor I would prefer rights since I at least have the option to subscribe to it and not dilute the value of my shares )

  4. Alan Lok, CFA said:

    First of all, thanks Joshua for your interest in our blog. It is not a clear black-and-white issue as to which one is better: rights versus share placement. For retail investors, they would prefer an across-the-board right issue which would give them a first right of refusal. For management, though, share placement to a small pool of institutional investors would be faster, less cumbersome, and at times truly strategic for capturing NPV-positive investment purpose. At the end of the day, it comes down to having the appropriate amount of disclosures, particularly on the rationale for having the fund-raising activity in the first place. In the super long run, though, corporate decisions must balance and optimize the benefits of various stakeholders.

  5. Zhu Yirong said:

    I’ve benefited a lot from this blog. As a minority investor, previously, I neither took any action when faced with the circumstances I did not understand, nor did I have any patience to learn related investing knowledge due to the cumbersome of collecting information. Thus, I can deeply understand how difficult it is for the appropriate investor education to be conducted. For one thing, many investors are lack of initiative of study, for another they don’t know what to learn because most existing investor education forums haven’t provided the right knowledge and tools they need. I think providing effective education can also help to stimulate the investors’ initiative of study and build the right investment view. But what type of investor education to be provided and how to conduct it is really a big problem. And I am really interested in it.
    Looking forward to your next blog post.

    • Alan Lok, CFA said:

      Thanks Yirong and so sorry for the late response. From the feedback I’ve received thus far, it is very encouraging that quite a handful of people are interested in this topic. Regarding your comment on the appropriate type of investor education and more effective ways to deliver it, I have the intention to undertake more intensive research and active observation and write a follow-up blog post. Meanwhile, please continue to follow our blog for the latest market integrity-related issues in the region. Cheers!

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