Question

Rights offering are cheaper than general cash offer and eliminate the problem of underpricing. Yet most new equity issues in U.S are underwritten general cash offer.

Requirement:

1) You are required to provide explanation on those statement above.

Answer 1

Rights offer Sale of new shares of company to existing shareholders on pro rata basis at discounted price.

General Cash offer   Sale of shares of company to outside investors.

Rights offer are cheaper than general cash offer because in cash offer shares are issued to outside investors and lot of formalities need to be fulfilled which is not in case of rights offer.Company can raise fund in faster way by issuing right shares without incurring underwrite fees.So rights offering are cheaper than general cash offer.

Underpricing means offering of shares at price less than price of first trade.Rights offer eliminate the problem of underpricing because in general cash offer investors do not have information about company .They show less interest to invest in company then underwriter reprice the offer price to encourage the investors to make bid which is not in case of rights issue .Existing shareholder are well informed.

In U.S a large firm can file a single new issue registration statement to SEC .This statement is valid for 2 years & in this period company can make general cash offer as it wants . That's why most new equity shares are underwritten on general cash offer in U.S.