A rights offering (also called a subscription right) is a mechanism by which a corporation allows existing shareholders to purchase newly issued shares at a discount to the current market price, before the shares are offered publicly. The preemptive right — the right to maintain proportional ownership — underlies rights offerings. Each shareholder typically receives one right per share owned; a certain number of rights are required to purchase each new share at the subscription price.
Rights have a very short lifespan, typically 30–45 days, after which they expire worthless. During this period, rights trade separately in the secondary market and can be sold by shareholders who do not wish to exercise them. This transferability ensures that shareholders who decline to participate are not economically disadvantaged — they can sell the rights for their market value.
The theoretical value of a right can be calculated: before the ex-date (rights-on), the formula is (Market Price − Subscription Price) ÷ (Rights Required + 1); after the ex-date (ex-rights), it is (Market Price − Subscription Price) ÷ Rights Required.
From the issuer's perspective, rights offerings are a cost-effective way to raise equity capital because underwriting fees are lower than in a traditional IPO. From the investor's perspective, receiving rights is neither taxable income nor a taxable event — the cost basis of the original shares is allocated between the shares and the rights.
> Exam tip: On the Series 7, know the formula for valuing rights before and after ex-date, and that rights are issued by the company (like warrants). Unlike warrants, rights have very short expiration periods. Remember that the cost basis of the original shares must be allocated proportionally to any rights received.