A rights offering is a way for a public company to raise capital by giving its current shareholders the first chance to buy newly issued shares, usually at a price below the market. If you own the stock on the record date, you receive one right per share, and those rights let you buy additional shares at a fixed discount. Rights have real cash value, so the decision you have to make is whether to exercise them, sell them, or watch them expire. The last option is almost always the wrong one.
How the Mechanics Work
Every rights offering has three numbers that define it: the subscription price, the subscription ratio, and the deadline.
The subscription price is the fixed price at which you can buy new shares. It sits below the current market price, typically by 15 to 30 percent. That discount is what gives a right its value.
The subscription ratio tells you how many rights it takes to buy one new share. A 5-to-1 ratio means five rights per share, so 500 shares of existing stock produces 500 rights, which lets you buy 100 new shares. The proportional design gives every shareholder the same opportunity to keep their ownership percentage intact.
Rights come in two forms, and the prospectus for the offering will tell you which one you have. Transferable rights can be bought and sold on the exchange during the subscription period, so a shareholder who doesn’t want to put up more cash can still capture the value. Non-transferable rights cannot be traded. If you don’t exercise them, they expire.
The Record Date and Subscription Window
You have to own the shares on the record date to receive rights. Buy the stock after that date and you get nothing. The company’s board sets the record date when it approves the offering.
The subscription period opens after the record date and runs short. Most offerings stay open for 16 to 30 days, though some extend to 60. The New York Stock Exchange sets a 16-day minimum for listed companies. Nasdaq and OTC markets don’t impose one. Miss the deadline and any unexercised rights are worthless.
The stock itself trades in two phases around the offering. Before the record date it trades “cum rights,” meaning a buyer of the stock also gets the attached rights. After the record date it trades “ex-rights,” and new buyers no longer receive them. The share price typically falls on the ex-rights date by roughly the value of the detached right.
Your Three Choices
Once rights land in your account, you have three paths. Each has a different financial outcome.
Exercise the Rights
You submit payment at the subscription price and receive new shares. This preserves your ownership percentage, your voting power, and your claim on future dividends. Because the subscription price is below market, you effectively lock in a paper gain on the new shares from day one. For shareholders who want to stay invested, this is the default.
Sell the Rights
If the rights are transferable and you don’t want to commit more capital, you can sell them on the open market. The market price of a right roughly equals the difference between the stock’s market price and the subscription price, divided by the number of rights needed to buy one share plus one. Your ownership percentage will shrink after the offering, but the sale proceeds partly compensate for the dilution.
Let the Rights Expire
This is the worst outcome. You get no cash, no new shares, and your ownership percentage still drops because everyone else’s stake grew. There is no scenario in which letting transferable rights expire beats selling them. The shareholders who end up here are usually the ones who weren’t paying attention.
How to Exercise
To exercise, you complete a subscription form and send payment for the full cost of the new shares to a subscription agent, typically a bank or trust company named in the prospectus. The agent holds the funds in escrow and issues the shares once the offering closes.
If your shares sit in a brokerage account, the broker usually handles the mechanics. You’ll get a notice, and the broker’s platform will let you choose to exercise, sell, or do nothing. Read that notice carefully. Most brokers let unexercised rights lapse by default, so silence is a decision.
Many offerings also include an oversubscription privilege. If you exercise all of your basic rights, you can request additional shares from the pool that other shareholders didn’t buy. When demand exceeds supply, the extra shares are allocated pro rata, and any excess payment is refunded.
The Cost of Doing Nothing
When new shares get issued below market price, the value of every existing share drops. Analysts estimate the post-offering price using the Theoretical Ex-Rights Price, or TERP: add the total market value of existing shares to the capital raised from the new shares, then divide by the new total share count.
A worked example makes it concrete. A company has 100 shares trading at $10, giving it a $1,000 market cap. It issues 10 new shares at a $5 subscription price, raising $50. The combined value is $1,050 across 110 shares, so the TERP is about $9.55.
A shareholder who exercised bought shares at $5 that are now theoretically worth $9.55. A shareholder who did nothing still holds stock that fell from $10.00 to $9.55, absorbing a $0.45 loss per share with nothing to offset it. That gap is the price of ignoring the offer, and it scales with the size of the issuance.
Tax Treatment
Receiving stock rights is generally not a taxable event. Federal tax law excludes distributions of stock or rights to acquire stock from gross income, with limited exceptions for disproportionate distributions and certain preferred stock situations.1Office of the Law Revision Counsel. 26 USC 305 – Distributions of Stock and Stock Rights
What follows depends on what you do with the rights.
If you exercise: the cost basis of the new shares is generally the subscription price you paid. Your original shares keep their original basis unless you elect to allocate basis between the old stock and the rights. The IRS draws a line at 15 percent: if the rights are worth less than 15 percent of the fair market value of your existing stock on the distribution date, the basis of the rights is zero unless you affirmatively elect to allocate. If the rights are worth 15 percent or more, you must allocate basis between the old stock and the rights, proportionally to their fair market values.2Internal Revenue Service. Publication 550 – Investment Income and Expenses
If you sell: the proceeds are a capital gain. Whether the gain is short-term or long-term depends on how long you held the original stock that generated the rights, not the rights themselves. If you didn’t allocate any basis to the rights, the entire sale is gain.2Internal Revenue Service. Publication 550 – Investment Income and Expenses
If they expire: nontaxable rights that lapse have no basis and generate no deductible loss. They simply disappear, and your original stock keeps whatever basis it had.
What the Announcement Signals
Rights offerings don’t always land well with the market. Issuing new shares below market value tells investors the company needs capital and couldn’t get it through channels that spare existing shareholders, like debt financing or a private placement. That reading isn’t always fair, but it’s the default.
The stock often dips on the announcement itself. The pending increase in shares outstanding, combined with the discounted price, creates selling pressure before the offering even opens. Earnings per share also drop mechanically once the new shares are issued, since the same profits get spread across a larger base. A company already under stress can find that the announcement accelerates the decline it was trying to fix.
Context still matters. A rights offering funding a strategic acquisition reads differently from one plugging a hole to avoid a covenant breach. Before you decide whether to exercise or sell, look at what the prospectus says the capital is for and whether the company’s fundamentals support putting more money in.