Rights issues: Retail shareholders and their participation decisions

• Published date: 01 September 2021
• Author: Hue Hwa Au Yong,Christine Brown,Choy Yeing (Chloe) Ho,Chander Shekhar
• Date: 01 September 2021
• DOI: http://doi.org/10.1111/irfi.12307

ORIGINAL ARTICLE

Rights issues: Retail shareholders and their

participation decisions

Hue Hwa Au Yong

1

| Christine Brown

1

| Choy Yeing (Chloe) Ho

2

|

Chander Shekhar

3

1

Department of Banking and Finance, Monash

Business School, Monash University,

Melbourne, Victoria, Australia

2

Department of Accounting and Finance,

University of Western Australia, Perth,

Western Australia, Australia

3

Department of Finance, University of

Melbourne, Melbourne, Victoria, Australia

Correspondence

Choy Yeing (Chloe) Ho, Department of

Accounting and Finance, University of

Western Australia, Perth, Western Australia,

Australia.

Email: chloe.ho@uwa.edu.au

Abstract

Using daily ownership data, this study documents median par-

ticipation rates for retail and institutional shareholders in rights

offers in Australia of 60% and 94%, respectively. At the

median, the rights issue results in 0.25% (1.34%) of the value

of firm market capitalization (offer size) being transferred from

retail shareholders to institutional shareholders. Retail share-

holder participation is higher in renounceable offers, offers

with larger discount and those made by firms with larger mar-

ket capitalization and lower risk. Companies with above

median retail participation rates perform better in the long

run. The results suggest that, on average, retail shareholders

make rational participation decisionsinrightsofferings.

KEYWORDS

abnormal returns, discount, institutional shareholder

participation, rational, retail shareholder participation, rights

issues, rights offers, wealth transfers

JEL CLASSIFICATION

G15; G32

1|INTRODUCTION

The traditional rights offer (RO) provides a mechanism for companies to raise capital from existing shareholders effi-

ciently, equitably, and at low cost. If all shareholders act rationally and take up their rights to purchase new shares,

there are no resulting wealth transfers between shareholder groups, even when rights are offered at a discount to

the current price. Yet, despite these positive attributes, the number of ROs issued by industrial firms in the U.S. has

Received: 18 September 2019 Revised: 27 February 2020 Accepted: 3 April 2020

DOI: 10.1111/irfi.12307

© 2020 International Review of Finance Ltd. 2020

International Review of Finance. 2021;21:917–944. wileyonlinelibrary.com/journal/irfi 917

diminished since the 1960s (Eckbo & Masulis, 1992). A similar trend for ROs is observed in later years in other coun-

tries such as the U.K., Canada, Japan, and Hong Kong (Armitage, 2010; Eckbo, Masulis, & Norli, 2007; Wu &

Wang, 2009). In turn, this has led to the “rights paradox”denoted by the puzzling co-existence of relatively low costs

associated with raising capital via ROs (compared to other forms of capital raising) and their infrequent use by com-

panies. As rights are typically “in the money,”shareholders are expected to participate in such offerings. Prior litera-

ture, most notably Holderness and Pontiff (2016), however presents results that are consistent with the view that

small shareholders in the U.S. tend to leave “money on the table”by not participating in valuable rights offerings.

1

They also suggest that the nonparticipation may be related to underlying agency problems that are signaled when

managers choose nonrenounceable (nontransferrable) offers.

2

Generally, the literature characterizes institutional

investors as “sophisticated”and retail (or small) shareholders as lacking financial literacy and sophistication, which

may lead to the lack of participation.

Typically, there is no legal requirement for firms to disclose participation rates in rights issues. As a result, data

to measure participation rates are generally unavailable to researchers. To date, apart from a study by Rantapuska

and Knüpfer (2008), there has been no research using actual participation rates of retail shareholders. Our study dif-

fers from previous research in one important aspect: we have access to share registry data that measure ownership

on a daily basis, for retail and institutional shareholders separately. This allows us to estimate accurately the owner-

ship changes following the first allocation of shares in a large sample of rights offerings. Ownership changes reflect

the attractiveness of the issue to different groups of shareholders, and are consequently an important determinant

of wealth transfers between the groups.

Our study is conducted on Australian data. ROs have a long history in Australia and remain popular today. Over

1999–2007, Australian companies raised around $21.43 billion via ROs.

3

Nonrenounceable offers are significantly

more popular than renounceable offers as more than two-thirds (68%) of offers are nontransferrable over our sample

period, which suggests that market participants in Australia are accepting of multiple offer structures, and that the

agency problems identified by Holderness and Pontiff (2016) are less likely to drive participation behavior by retail

shareholders. Further, ROs are also characterized as fair by the regulator, because they satisfy the “equal opportunity

principle.”

4

In view of these observations, our central hypothesis is that when offered the opportunity to buy shares

in a RO, retail shareholders in Australia in fact make rational participation decisions.

5

We document empirical evidence to answer our research question by investigating the drivers of participation

decisions for retail shareholders. If the participation decisions of retail shareholders are driven systematically by a set

of factors that reflect either firm or offer quality, we are led to conclude that retail shareholders (as a group) are

rational in their exercising behavior. It is important to emphasize at the outset, that we do not have data that identify

shareholders at the individual level; our daily ownership data are at the aggregate level for the two groups of share-

holders, retail and institutional. Consequently, we are unable to measure the financial sophistication of individual

retail shareholders, as Rantapuska and Knüpfer (2008) do, but we do have a much larger sample size.

The ownership data allow us to account for market participants who buy or sell shares up until the cum-

entitlement date of the RO. The measure of retail and institutional shareholder ownership on the cum-entitlement

date determines eligibility to participate in the RO. We quantify the number of shares purchased by retail and institu-

tional shareholders based on the first allocation (before unsubscribed rights are sold in a shortfall or oversubscription

offer). The retail (institutional) shareholder participation rate is defined as this number divided by the number of

shares retail (institutional) shareholders are eligible to subscribe for under the RO. This approach allows us to calcu-

late accurately retail and institutional shareholder participation rates in the RO. Our sample of 387 ROs during

1999–2007 has a mean (median) retail shareholder participation rate of 59 (60)%; the mean (median) institutional

participation rate is 102 (94)%. The mean (median) participation rate for all shareholders is 101 (79)%.

6

The conse-

quence of differing participation rates between the two shareholder groups is an average (median) wealth transfer of

1.19 (0.25)% of market capitalization and 6.32 (1.34)% of the funds sought, from retail shareholders to institutional

shareholders. By way of comparison, Holderness and Pontiff (2016) report an average (median) participation rate of

64 (71) percent for the entire shareholder group, and an average wealth transfer from nonparticipating to participat-

ing shareholders of 4.5% (7%) of market capitalization (funds sought). Of course, if institutional shareholders at large

918 AU YONG ET AL.