Control Expropriation Via Rights Offers

Abstract

Rights offers are a relatively common capital-raising method. In a rights offer, the company's existing shareholders are given the opportunity to purchase newly-issued shares in proportion to the amount of shares they already own for a specific subscription price per share. Because all shareholders can participate in the issuance under the same terms, rights offers are often regarded as fair to all shareholders. However, this article demonstrates that rights offers do not always place shareholders on equal footing. In particular, this article shows that dominant, non-controlling shareholders (“insiders”) can utilize a rights offer to expropriate control. By setting a deliberately high subscription price, insiders can deter other shareholders from buying into the offer. Insiders can then purchase a disproportionate amount of shares via the rights offer, thereby securing absolute control. Once in control, insiders will be in a position to extract value from the firm, and will be immune to future control challenges. These expected benefits of control make the high subscription price worth paying from insiders' perspective, so that the rights offer is effectively underpriced for insiders but overpriced for other shareholders. When a rights offer acts as a change-of-control tool, it should be governed by Delaware takeover law. Courts should closely scrutinize such issuances, and require boards to maximize the premium insiders pay for control. This article further suggests that stock exchanges adopt a mandatory price-adjusting mechanism for rights offers, which will guarantee that the subscription price is lower than or equal to the underlying share's trading price.