Use and abuse of rights issues. Do they really protect minorities?

This paper discusses the use of rights issues when interest conflicts between controlling shareholders and minorities arise due to the existence of private benefits that the former can extract from the value of a listed company. While the literature considers the issue of pre-emptive rights as an essential tool to protect minorities from expropriation, we propose a model where rights are used to enforce the subscription of seasoned equity issues, even at negative conditions for investor’s value. We define an abuse condition allowing a controlling shareholder to choose discretionally an issuing price, granting a discount with respect to the market price, so that minorities either undertake the issue or sell the rights, minimizing an exit cost that greater than zero in all cases. As the rights issue never fails under these condition, we define this phenomenon as "enforced subscription". This model fits the Italian legal framework, and many other international contexts where rights issues are dominant. We report the case of Alitalia’s rights issue in 2005 as a typical example of "enforcement at work". As rights issues at a high discount often involve an abuse of power by the controlling shareholder, we argue that their use should be carefully regulated.