RIGHTS ISSUES, PRIVATE BENEFITS AND NEGATIVE-NPV INVESTMENTS

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Abstract

This paper discusses the use of rights issues when interest conflicts between controlling shareholders and minorities exist, due to the existence of private benefits that the former can extract from the value of listed company. While the literature considers the issue of pre-emptive rights as an essential tool to protect minorities from expropriation, we propose that pre-emptive rights are used to enforce the subscription of seasoned equity issues. We define an abuse condition as the case when a controlling shareholder choose discretionally an issuing price, granting a discount with respect to the market price, and "enforce" minorities to undertake a negative-NPV investment. Minorities do so because they are minimizing an exit cost that is greater than zero. As the rights issue never fails under these conditions, we define this phenomenon as "enforced subscription". This model fits the Italian legal framework and many other international contexts where rights issues are dominant. We report the case of Alitalia’s rights issue in 2005 as a typical example of "enforcement at work". As rights issues at a high discount often involve an abuse of power by the controlling shareholders, we argue that their use should be carefully regulated.

Keywords: Equity Issues, Rights Issues, Private Benefits, Minority Protection

How to cite this paper: Meoli, M., Paleari, S., & Urga, G. (2008). Rights issues, private benefits and negative-NPV investments. Corporate Ownership & Control, 6(2-1), 238-245. https://doi.org/10.22495/cocv6i2c1p7