Subscription Price: Rights Offering and Subscription Warrants

The Subscription Price is the price at which existing shareholders of a corporation are entitled to purchase common shares during a rights offering, or the price at which subscription warrants can be exercised.

The Subscription Price is the predetermined price at which existing shareholders of a corporation are entitled to purchase additional common shares in a rights offering or the price at which subscription warrants can be exercised. It is usually set below the current market price to incentivize participation by existing shareholders, thereby raising additional capital for the company.

Context and Importance in Corporate Finance

Rights Offering

A rights offering, also known as a rights issue, is a way for companies to raise capital. It grants existing shareholders the right to purchase additional shares at a price below the current market price (the subscription price). This maintains the proportionate ownership of existing shareholders and prevents dilution.

Subscription Warrants

Subscription warrants give the holder the right, but not the obligation, to purchase a company’s stock at a specific price (the subscription price) before a certain date. Warrants are often issued to incentivize potential investors or raise additional funds.

Formulas and Calculations

Pricing and Dilution Formula

To determine the impact of a rights offering on share price and ownership dilution:

$$ N = \frac{\text{Number of existing shares}}{\text{Number of rights needed to buy one new share}} $$

Where:

• \( N \) = Number of new shares
• Rights offer price \( P_{R} \)
• Market price before rights issue \( P_{M} \)

Total shares after rights issue \( N_{\text{total}} \):

$$ N_{\text{total}} = \text{Existing Shares} + N $$

Dilution adjustment:

$$ Adjusted\ Market\ Price = \frac{(P_{M} \times \text{Existing Shares}) + (P_{R} \times N)}{N_{\text{total}}} $$

Examples

Example 1: Rights Offering

A company with 1,000,000 shares offers a 1-for-5 rights offering at a subscription price of $10 when the current market price is $12.

1. Number of new shares: \( N = \frac{1,000,000}{5} = 200,000 \)
2. Total shares after offering: 1,000,000 + 200,000 = 1,200,000
3. Adjusted Market Price:

$$ \frac{(12 \times 1,000,000) + (10 \times 200,000)}{1,200,000} = \frac{12,000,000 + 2,000,000}{1,200,000} = \frac{14,000,000}{1,200,000} = 11.67 $$

Example 2: Subscription Warrants

If a company’s stock is trading at $15, and it issues warrants exercisable at $12, the warrant holders will likely exercise if the stock price rises above $12, thus benefiting from the lower price.

Historical Context

The concept of subscription prices and rights offerings has a long history in stock markets worldwide. Initially devised as a method to prevent ownership dilution, rights offerings have been crucial for companies in need of rapid capital infusion through existing shareholders, ensuring shareholder loyalty and confidence.

Comparison with Similar Terms

• Public Offering Price (POP): The price at which new shares are offered to the public in an initial public offering (IPO), typically higher than the subscription price.
• Strike Price: Refers to the fixed price at which the holder of an option can buy (call) or sell (put) the underlying security; similar to a subscription price but pertains to options rather than rights or warrants.

FAQs

What is the key advantage of a subscription price for shareholders?

The primary advantage is the opportunity for existing shareholders to purchase additional shares at a price typically below the market value, helping them maintain their ownership proportion and potentially gain more profit.

Is the subscription price always lower than the market price?

Yes, generally, the subscription price is set below the current market price to make the offering attractive to the shareholders and ensure success in raising capital.

How does the subscription price affect share dilution?

The subscription price mitigates dilution by giving existing shareholders the first right to purchase additional shares, thus maintaining their proportional ownership in the company.

References

• Ross S.A., Westerfield R.W., Jaffe J.F. “Corporate Finance”. McGraw-Hill Education, 2016.
• Investopedia. “Rights Offering Definition.” Link
• Securities and Exchange Commission (SEC). “Public Offerings.” Link

Summary

The subscription price plays a crucial role in rights offerings and the issuance of subscription warrants, providing a mechanism for companies to raise additional capital while giving existing shareholders the advantage to maintain their ownership stakes at a lower cost. Understanding the dynamics of subscription price helps investors make informed decisions regarding their participation in such offerings.