The term "Shareholder Rights" has been around in Wall Street for a very long time.  Some states implemented anti-dilution laws more than a century ago; they are meant to protect the pro rata ownership position of corporate shareholders. Even where the law does not require it, many corporations provide what amounts to a right of first refusal for existing shareholders to maintain their pro rata position. When required by state statute, an anti-dilution Rights Offering is more commonly known as an exercise of preemptive rights (the contemplated shareholder dilution is preempted by the Offering).

The aspiring capitalist may not fully recognize all implications of a "Rights Offering"; and that is why I discuss it below.  As for continuing relevance today, Jamie Dimon, CEO of J.P. Morgan Chase, mentioned the need for Rights Offerings in his most recent Letter to Shareholders, published in March 2009.  He asserted that banks should be able to make expeditious Rights Offerings to its shareholders as a way of rapidly building up equity capital during a financial crisis.¹Under the exigent circumstances that Mr Dimon contemplates for future banking contingencies, his is almost certainly a good idea. However, as a more general matter, the full implications of Rights should be understood by the aspiring capitalist before being presented a fait accompli.

Here is a simplified example of how a Rights Offering might look in practice:

The XYZ Corp. has 100 million shares authorized, issued, and outstanding; and the total shareholder equity (net worth) of the firm is $500 million. As a result, the per share net worth of XYZ Corp (or its Book Value) is $5 per common share. Imagine that the state of Euphoria's Pension Fund owned 20 million common shares of the XYZ Corp; it would hold a position of 20 percent ownership.  Subsequently, the Board of Directors decides that it is necessary to raise additional capital for expansion of business to New England.  Further, the Board agrees that if it sought to borrow the money, a high interest rate might be demanded from creditors (XYZ's Balance Sheet is shaky).  Instead, the Board decides that the money will be raised by offering an additional 20 million shares to the public, after providing existing shareholders a Rights Offering.  

Common shareholders would be given a short timeline (two to four weeks) to take advantage of the anti-dilution Offering at a price below what will be charged to the public, and to maintain their pro rata ownership position in the firm. For example, if shares will be offered to the public at $10, the Rights Offering might provide that existing shareholders can purchase the new stock at $8 per share. 

In our example above, the State of Euphoria's Pension Fund would need to purchase an additional four million shares, so as to continue a 20 percent ownership of XYZ (now needing 24 million of 120 million shares soon-to-be outstanding). The math of the anti-dilution exercise is pretty easy:  an additional four million shares would have been purchased at $8 per share; and so, the Treasury of the State of Eurphoria would be drained an additional $32 million dollars. And what did Euphoria gain?  Nothing.  It simply did not lose any of its position in owning a full 20 percent of the XYZ firm. 

Here, however, lay the daunting issue first eloquently summarized by John Burr Williams in his investment classic, The Theory of Investment Value. Williams opined that any so-called "Rights Offering" might also be aptly characterized as an assessment against owners.  He stated that assessments/rights (cash paid by shareholders to the corporate treasury) and dividends (cash paid to shareholders from the corporate treasury) were two sides of the same coin.²  Assessments, or Rights, may alternatively be called "Reverse Dividends".

Williams reasoned that if a common shareholder received annual cash dividends for a number of years, but then had to give back those accrued dividends in a single lump payment, then the Rights Offering amounted to an assessment that owners were forced to pay (or concede dilution of holdings).  Illustratively, imagine that a shareholder receives $1 per share in annual cash dividends from XYZ for eight years. If a Rights Offering at the beginning of Year 9 requires the payment of $8 per share to maintain one's pro rata ownership position in the firm, then it is not difficult to imagine that the owner is effectively forfeiting the previous eight years of cash dividends.  Williams referred to the first set of annual dividends as "gross dividends"; and the balance of dividends after payment for required assessments (rights offerings), as the "net dividend" of a corporation.³

The problems associated with shareholder dilution and reverse dividends are not insurmountable; however, most people engage in stock-related transactions without ever fully understanding that these problems exist in the first place. 




1. Jamie Dimon, CEO of JP Morgan Chase, Letter to Shareholders (2008 Report), pg. 23.
2. Williams, John Burr The Theory of Investment Value, pp. 61-64.  Here Williams discusses assessments (rights), gross [or cash] dividends, and a company's pure, or net annual dividend.  
3. Ibid.