What is the Right Entitlement of Stocks? Explained

Understanding Rights Entitlement

Rights Entitlement (RE) are the temporary securities that represent shareholders' eligibility to apply for the rights issue. REs are offered to shareholders based on the ratio of existing equity shares held on the record date.

The record date is a specific date set by the company to determine which shareholders are officially holding the company shares. If the name appears on the shareholding list, that shareholder will be eligible to receive various corporate benefits such as dividends, bonus shares and rights issue.

When a company wants to raise additional capital from the market, it might take a route of floating new shares to the market. To give benefits to its existing shareholders, a company gives the right to purchase new shares at a discounted price.

The shareholders have an option to either buy the new shares at a discounted price or let the opportunity lapse. However, the latest update by SEBI allows shareholders to sell the rights entitlement to another person at an agreed price.

Why Rights Entitlement?

Rights Entitlement offers a simple online way for existing shareholders to apply for the rights issue. It removes the need to do physical paperwork for settling the rights. This makes the entire process of rights issue faster and more convenient for market participants.

Previously, companies required nearly two months to complete the process of a rights issue, so it discourages companies from raising additional capital from this route. With electronic credit of rights entitlement, the process is seamless, improving efficiency and reducing delays.

Benefits of Rights Entitlement

The main benefit of rights entitlement is that anyone can buy the rights from the stock market. Suppose ABC company is coming with a rights issue, and rights entitlement is offered to the existing shareholders. But, you are not an existing shareholder of ABC company, so how will you get the REs? You can buy the REs from the secondary market if any existing shareholder is ready to sell their rights entitlement.

REs are at a discounted price, which allows the new shareholders to own the ABC company shares at a lower price compared to the market price.

How is the Rights Entitlement Price Determined?

Initially, the rights entitlement price is determined by a formula (Market price of share + Rights issue price).

Example: If the stock price is ₹200, the rights issue price is ₹50, then the REs base price is ₹150.

Later, when rights entitlement starts trading, it is determined by supply and demand in the market. Higher demand for RE pushes the price higher, and lower demand pushes the price down.

The price of rights entitlement is completely linked with underlying stock price.

Impact of Rights Entitlement on Actual Share Price

Rights Entitlement impacts the actual share price in a slightly negative way, as the supply of shares increases in the market. However, this short-term price drop can be offset by long-term growth in business.

When the raised capital is used efficiently in the business, for expansion or debt reduction, the share price may recover soon.