Rights Issues: Shareholders ‘over the barrel’

Chris Mallin is Professor of Corporate Governance and Finance & Director of the Centre for Corporate Governance Research at the University of Birmingham. She is the author of Corporate Governance and she was the editor of Corporate Governance: An International Review 2000-2007. She is a member of the International Corporate Governance Network (ICGN) and has been on two of the ICGN’s working parties established to draft guidelines on international corporate governance principles, and on global voting. She blogs with fellow OUP author Bob Tricker at Corporate Governance. The below post is an adapted version of a post from that blog, and highlights the volume of rights issues coming to the market and the corporate governance implications for investors, both institutional and private.

Rights issues have been a traditional way to raise funds from existing shareholders in the UK, Europe and Australasia. Existing shareholders are offered the chance to acquire new shares, at a discount, in proportion to their existing holding. In general the reasons for a rights issue fall into one of three categories: raising funds for an acquisition or expansion; (ii) internal working capital requirements; (iii) restructuring of the balance sheet. The latter often occurs in times of financial distress and it is for this reason that many of the companies seeking to raise money through rights issues are doing so now – they need to raise cash and asking existing shareholders is one of the few ways to do it.

Banks and property companies making most rights issues

It has been noticeable that many UK companies are making rights issues at present. Many of the companies seeking to raise funds in this way are in sectors particularly badly affected by the economic downturn: the banking sector and the property sector.

HSBC, in the largest rights issue in UK history, is seeking to raise more than £12 billion from its investors. Peter Thal Larsen, Neil Hume and Kate Burgess in their article ‘HSBC to seek £12bn in record offering’ state that HSBC ‘is the latest in a long line of global banks to seek to strengthen its capital reserves by issuing shares’.

Peter Thal Larsen in his article ‘HSBC’s search for capital gives market the shudders’ reports that ‘…the bank’s decision to raise £12.5bn in fresh capital from its investors and cut its dividend for the first time any of its executives can remember was bound to send a shudder through the markets’. However HSBC is still seen as being in a stronger position than many other banks, and Stuart Gulliver, HSBC Chief Executive of Global Banking and Markets, stated ‘The rights issue is designed to get us a bullet-proof balance sheet’.

In their article ‘Segro to seek discounted rights issue’, Daniel Thomas and Neil Hume highlight Segro is seeking to raise 3300 million and that other property sector companies including Land Securities, British Land, and Hammerson have already approached investors with rights issues to the tune of more than £2 billion in recent weeks.

In similar vein, David Fickling, Kate Burgess and Neil Hume in their article ‘Debt-laden Wolseley close to launching £1bn rights issue’ highlight the plight of Wolseley, the builders’ merchant whose ‘loss-making retail division [was] heavily exposed to the stagnant US housing market’.

Governance implications

There are governance implications for all shareholders, both private and institutional. It is not just a matter of concern to investors in the country in which rights issues are taking place, but a matter for all investors. Therefore US investors with cross-border shareholdings, for example in the UK, will be faced with these governance implications. Shareholders taking up the rights will retain the same proportion of the share capital overall as they had prior to the rights issue. However shareholders not taking up the rights issue shares will have a lower proportion of the company’s share capital than they did prior to the rights issue i.e. their stake will be diluted. To avoid any dilution that would occur when companies do not offer shares to their existing shareholders first, in some jurisdictions the concept of pre-emption rights (that is, new shares have to be offered to existing shareholders first) has long been enshrined in company law. However as Oliver Ralph points out in his article ‘The begging letters start to arrive’, noted ‘The institutions are getting uppity because they, too, have been left out on certain occasions. Witness the outrage that Barclays provoked when it raised money from Middle East investors last year. More recently, Rio Tinto has enraged its institutional shareholders by offering convertible bonds on favourable terms’.

There are clear governance implications where investors’ shareholdings are diluted and equally the investors are somewhat ‘over a barrel’ as if they wish to avoid dilution, they have to pour more money into companies for reasons, and at a time, when they may not wish to do so.

There were also some problems with rights issues last year, including low take-up rates, and claims of market abuse through short-selling, and as a result the Rights Issue Review Group was established and reported back late last year. The full report ‘A Report to the Chancellor of the Exchequer: by the Rights Issue Review Group’ is available here.

Following the Review, the Association of British Insurers (ABI), an influential body representing the collective interests of the UK insurance industry, altered its guidelines on rights issues so that companies will be able to issue new shares amounting to up to two-thirds of their existing issued share capital (previously one third) without obtaining shareholder approval. The purpose of the change is to facilitate rights issues.

Rights issue wave

It remains to be seen how many more companies will make rights issues but at the present time it seems a good option for companies, many of which are in dire need of a cash injection, although investors may be becoming wary and viewing rights issues as a case of good money after bad.