Why preferential allotment is innately flawed in the face of rights issue

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The rights issue is fairer any day. It is for the existing shareholders to take a call on the offer of additional shares. If they find the offer unattractive in view of the high asking price, it is their call.

Why preferential allotment is innately flawed in the face of rights issue
Shareholders dominant or others don’t like dilution of their share of the net worth in the company. Most of the IPOs are, therefore, preceded by hefty bonus issues and cash dividends lest the Johnny-come-latelies i.e. the new shareholders do not get to share the spoils assiduously built by the promoters.
To be sure, premium over par value on IPO is also a balancing mechanism to compensate the promoters for their toils but then promoters love emptying the coffers clean in the run-up to IPO. So much so, for the avid market watchers, attractive bonus issues accompanied by hefty dividend payout are definitive straws in the wind—IPO is in the offing.
Small wonder, 1977-78 witnessed a flurry of bonus issues following the then Industries Minister George Fernandes’ peremptory order to the so-called FERA companies to bring down their promoters’ shareholdings to 40 percent which inevitably called for public issues if they wanted to stay in India. Many complied but a few like Coca-cola and IBM chose to leave. The point is shareholders guard their turfs assiduously by helping themselves to a generous payout or bonus issue so that new entrants do not lay claim on what arguably has been built without their capital.
If the promoters can be so insular, possessive and protective, what is wrong if the retail investors too seek fair compensation whenever someone makes inroads into their share of the pie. For, sauce for the goose cannot be anything else for the gander! Indeed the company law in India has not been unmindful of their concerns and rights which is why it has mandated rights issue as the norm whenever a public limited company seeks to increase its capital.
So the law mandates that the additional shares would be offered strictly in proportion to the existing holdings of the existing shareholders. However, all noble laws leave an escape route that is latched onto often with alacrity to the detriment of the small stakeholders. The company law says the rights issue norm isn’t cast in stone—it can be set aside should a special resolution be passed. In view of the low stakes, small shareholders have and the corresponding greater stakes promoters enjoy, such resolutions have been shoo-ins.
It is against this backdrop that the proxy advisory firm Stakeholders’ Empowerment Services’ (SES) call to the institutional investors to raise the banner of revolt in the PNB Housing Finance’s EGM and vote against the resolution-making preferential allotment in favor of Carlyle, Aditya Puri’s family investment vehicle Salisbury Investments, General Atlantic and Alpha Investments at Rs 390 per share strikes a chord with many corporate observers and commentators.
To be sure, it will be followed by an open offer to the public by the acquirers to acquire at least 26 percent of the capital at Rs 403 but that is not the same as making a rights issue. The market recorded a 94 percent spurt in a week to touch a dizzying Rs 852 which has been dismissed by some as an aberration, a temporary euphoria to celebrate the imminent induction of Aditya Puri, who had recently hung his boots in HDFC Bank after steering it to success for decades, in the Board of Directors. Be that as it may, the issue is a rights issue or preferential allotment, period.
The rights issue is fairer any day. It is for the existing shareholders to take a call on the offer of additional shares. If they find the offer unattractive in view of the high asking price, it is their call. They can spurn the offer. If they want to subscribe partially once again it is their call. They can renounce the offer either fully or partially. The renouncement itself does not go unrewarded if the future is good for the company. Preferential allotment smacks of a hush-hush backdoor entry on the sly.
Buying out the existing shareholders’ entitlements at a fair price as determined in the market is any day more honorable to the newcomer and fairer to the small investors. In a lateral entry, as it were, the new promoters would be required to pay the rights issue price to the company and renouncement compensation to those who renounce their rights in favor of the new entrants. The combined outgo would be a fairer price for the lateral entry.
—S. Murlidharan is a CA by qualification and writes on economic issues, fiscal and commercial laws. The views expressed in the article are his own
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