(4) Poor Credit Ratings Of Underlying Company
It is one of the most critical reasons why small investors opt to move away from rights issue. Credit rating is an estimate or assessment of creditworthiness of a company to fulfill their financial commitments. It is usually assigned by credit rating agencies for a prospective debtor.
Some of the most reputed credit rating agencies worldwide include Moody’s Investors Service, Standard & Poor’s (S&P) and Fitch Ratings.
Credit ratings are usually built on the basis of credit history, present financial position as well as likely future income of the underlying company. These are mostly expressed on an alphanumeric scale.
A high credit rating is an assurance regarding the safety of money & that it will be paid back along with interest on time by the borrower. Companies with high credit rating will be seen as low/no risk borrowers.
Therefore, banks will easily approve cheaper loans to them. These types of companies can also raise funds through rights issue quite easily due to confidence of shareholders in them.
On the other hand, a low credit rating indicates that the borrower (underlying company) carries the higher risk of default. Banks are often unwilling to give loans to such companies due to poor credit rating or associated risks of default.
It may be due to the company not performing well; its sales are diminishing or dimming future growth prospects. These types of companies when bring rights issue then investors do prefer to stay away from them.
However, the value of credit ratings for securities has been widely questioned. It is because hundreds of billions of securities with high credit ratings were downgraded to junk during financial crisis of 2007-08.
Thus, investors are advised to analyze a given issue by their own efforts as well rather than blindly following a credit rating agency.
(5) Companies Inability To Pay Even For Floatation Cost
It is one of the most important reasons why small investors opt to move away from rights issue. Floatation cost is the total cost incurred by an underlying company for issuing new securities or bonds. Companies are usually well advised to consider the magnitude of floatation cost on the amount of capital to be raised from an issue.
Some of the common expenses involved in floating shares in the market include underwriter’s fees, legal fees, registration fees, government fees, cost of printing the certificate, as well as other associated charges.
Rights issue is also not immune to these charges. But, the magnitude of floatation cost in rights issue is less as compared to other issues such as IPOs, FPOs, etc.
However, several investors think that company may be out of funds during difficult times. They may question the company’s ability to pay even for floatation cost.
Thus, small investors may opt to move away from rights issue.
- Reasons Why Small Investors Stay Away From Rights Issue: Shutterstock