How do you value the rights in a rights offering, and what determines whether shareholders should exercise or sell?

A rights offering gives existing shareholders the option to purchase new shares at a discounted subscription price, preserving their proportional ownership. The theoretical value of a right depends on whether shares trade cum-rights or ex-rights.

Cum-Rights Value:

Value of one right = (Market price cum-rights - Subscription price) / (N + 1)

where N = number of existing rights needed to buy one new share.

Ex-Rights Value:

Value of one right = (Market price ex-rights - Subscription price) / N

Worked Example:

Fenwick Industries trades at $48 per share and announces a 5-for-1 rights offering at $36 per share (5 rights needed for 1 new share).

• Cum-rights value = ($48 - $36) / (5 + 1) = $12 / 6 = $2.00 per right
• Theoretical ex-rights price = $48 - $2.00 = $46.00
• Ex-rights value check = ($46 - $36) / 5 = $10 / 5 = $2.00

Exercise vs. Sell Decision:

A shareholder should be economically indifferent between exercising and selling if the right trades at its theoretical value. However:

1. Exercise if you want to maintain your ownership percentage and believe the stock is undervalued
2. Sell if you need liquidity or believe the diluted share price will decline below the theoretical ex-rights price
3. Do nothing is the worst outcome — you lose value equal to the right's worth without any compensation

Key Insight: The rights offering itself does not create or destroy value for existing shareholders in theory — it merely transfers value from old shares to the right. The subscription price discount is offset by dilution. What matters is how the company deploys the capital raised.

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