What is the reason for the issuance of rights issue? Why is it called a cheap source of financing? And more importantly; What is the impact on the share prices of the issuer?

If it is seen from the purpose, an issuer conducts rights issue in order to obtain cheap financing, which can be used for business expansion, for working capital and also can be used to repay loans. Rights issue is positive if the fund raised is invested in projects particularly those which promise high yield, either a new investment project or an increase in working capital. However, if it is only used to repay debts, this gives an indication to the market that the management has difficulties repaying loans or it is burdened with high interest expenses. Consequently the return for investors is a bit doubtful if the fund raised from rights issue is only used to repay debts.

Right Issue is one form of equity financing or financing with equity addition. Thereby investors who finance it will gain investment return in the form of capital gain and/or dividends. But especially for the dividends of ordinary shares, there is no obligation for the management to share dividends. This is the contrary of the debt financing, for example with bank loans or with bonds issuance. For this purpose the management must gradually pay the interest and the principal debts. As a result, rights issue can be considered as a cheap method for companies to obtain financing.

In summary, generally rights issue will give negative signal to the market. Why? First, the company seeks a cheap financing because it is has no obligation to pay investment return. Second, rights issue indicates that the investment that will be conducted has no guarantee of return since the company does not choose debt financing which obliges certain level of return. The option for debt financing is more favoured by the market, because the company will always be under the supervision of creditors. Then we can easily conclude that generally rights issue is despised by the market and can result in a decrease in shares value.

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