The costs companies face in raising money via a rights issue have been almost exhaustively studied. The Office of Fair Trading (OFT), as it was then called, studied the market at least three times, most recently in 2011, when it issued a set of recommendations to reduce fees. A year before that, the Institutional Shareholders Committee produced its own Rights issue fees inquiry. That followed a Rights Issue Review Group, followed up by recommendations for implementation by the Financial Services Authority, now the Financial Conduct Authority. Numerous academic studies over the past two decades have added ballast to the argument that, while costs have been falling elsewhere across the financial services industry, the costs of issuing new equity remain stubbornly high.

A few recent examples suggest little has changed. Mining group Lonmin paid the bankers who arranged and underwrote its fees of $26m on its $407m rights issue in 2015, or 6.4% of the amount raised. Yet the new shares were offered at a massive 94% discount to the price of the existing shares. While this was undoubtedly a rescue issue to save it from imminent collapse, a large proportion of the issue was underwritten by one of its largest shareholders. Standard Chartered, the banking group, paid £55m – or 1.67% of the proceeds – for its £3.3bn rights issue, which was offered at a near 30% discount – despite the fact that it already had irrevocable acceptances for almost a fifth of the new shares. RPC, the design and engineering company, had to pay fees of 2.4% and offer a 35% discount for its £232.6m rights issue – yet the issue and the acquisition that accompanied it were so well received that the company’s shares actually rose on the day.

And the evidence suggests that underwriting is not a particularly risky business, with issue failures relatively rare – although when they do happen, the stock left with underwriters can be significant. Much of BP’s £7bn share issue was left with the underwriters when it straddled a market crash in 1987, while many of the refinancing issues by banks during the financial crisis had a very low take-up.  

Undermining corporate investment?Meziane Lasfer, Professor of Finance at Cass Business School, says the “big concern” is that fees are actually increasing. He points to research from some of his Cass colleagues, which showed that rights issue fees had risen from an average of 2.75% before the financial crisis to 4.1% after it, while the average discount for the new shares had widened from 27.9% to 38.9%. While take-up among investors also fell slightly, at 76% it was still relatively healthy.
"It may be the result of companies not negotiating cost-effective outcomes with investment banks, and shareholders not putting sufficient pressure on companies raising equity capital to reduce costs"“The fees for an initial public offering are around 11%, so 4% may seem to be acceptable,” said Lasfer. “But relative to the issuance of debt, which is negligible for debt raised privately from banks and 1.5% to 2% in the bond market, 4% is very expensive.”

He added that the high fees could actually be undermining corporate investment and points out that the number of rights issues have been relatively low in recent years. “If issues were less expensive, I would probably expect more companies to come to the market. Given the relatively high fees, many investments will not be undertaken – especially among smaller or medium-sized companies, who might find it harder to borrow from banks or via bond markets.”

No lack of competitionThe reports mentioned above all grappled with the issue of why fees are so high. The OFT said that it did not believe there was a lack of competition as there were a reasonable number of investment banking groups offering these services; nor was there evidence of a conflict of interest between the investment banks, institutional shareholders and the companies raising equity. Instead, it concluded: “[It] may be the result of companies not negotiating cost-effective outcomes with investment banks, and shareholders not putting sufficient pressure on companies raising equity capital to reduce costs. We have found that companies, albeit sophisticated purchasers of services generally, typically lack regular, repeated experience of equity-raising and are not focused principally on the price they are paying for equity underwriting services when they issue shares.”

The Rights Issue Review Group concurred, but cited other factors that could be pushing fees up. Among these were the opacity of fees, which made it difficult to establish what was being paid to whom, and a reduction in the proportion of UK shares owned by UK institutions from around 60% to 40%. Foreign shareholders, it said, are unwilling or unable to underwrite issues, which may put pressure on fees.  

But it added that the risks of underwriting had also fallen, with companies now generally discussing finance raising in confidence with shareholders before an issue is launched. It noted, however, that fees have not "reduced commensurately with the lower risks resulting from these changes”.

Inelastic demandSeth Armitage, Professor of Finance at the University of Edinburgh Business School, says that rights issues have largely been superseded by placings, which now account for far more equity offerings – in 2015, for example, there were just eight rights issues, raising a total of £5.5bn, compared with 539 placings raising £11.98bn, according to statistics from the London Stock Exchange. He believes that this reflects the fact that, particularly for smaller companies, there may not be much trading in the shares and that they face inelastic demand. 

“You cannot suddenly sell a load of new shares in a small company, so investment banks and brokers need to work up demand, talk to investors, do roadshows and so on,” says Armitage. “There are reasons in that case why they are earning their fees.”

Research by Cass shows that the fees for placings have remained relatively stable but, at around 3.9%, they are similar to rights issues. Placings can, however, discriminate against some shareholders – particularly private investors, who may not get the opportunity to participate. Roger Lawson, Deputy Chairman of ShareSoc, thinks only about a quarter of placings include an open offer, which gives all shareholders the chance to buy shares.

Armitage thinks investors should be concerned about high fees: “Shareholders should want companies to get a good deal on whatever they do: raising equity is not any different to other expenses, such as investing in a new property. Investors would want [the company] to get a good price for that.”

An intractable problem?The best solution to the issue of high fees may be, as the various reports have suggested, to encourage companies to push their advisers to lower costs. But raising finance can be crucial for a company, whether to secure its future, finance a deal or pay for a major investment. Securing the level of fees may not be their top priority when companies are focusing on raising finance, often to accompany a deal. While changing advisers may allow them to access a cheaper deal, the market can react badly, regardless of the reason. It can also take time for new advisers to familiarise themselves with the company sufficiently to guarantee the success of a fundraising. The level of fees may, therefore, remain an intractable problem. 

Jargon buster
Rights issue	The sale of new shares in a quoted company to raise funds. Existing shareholders will be offered new shares pro-rata to their existing holdings. This will generally be underwritten by the company’s broker or investment banker, or a consortium of them, who guarantee to buy any shares not subscribed for by existing investors.  These underwriters will reduce their risk by sub-underwriting the issue. The sub-underwriters will generally be drawn from the existing shareholders and other institutions. Both the underwriters and sub-underwriters charge a fee. A prospectus must be prepared and the rights issue has to be for at least ten trading days. The new shares are generally offered at a discount to the existing shares. Any new shares not subscribed for in the rights issue may be placed in the market after the issue has closed.
Placing	Instead of offering new shares publicly, the shares are placed with a range of institutions, some of which may be existing shareholders. This can be accompanied by an open offer, under which existing shareholders have the right to subscribe for, or clawback, some of the shares placed with institutions.