ACCA Advanced Financial Management (AFM) Practice Exam

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What is the main reason for conducting a rights issue?

Enhance liquidity of the company
Allow existing stockholders to maintain their ownership percentage
Obtain capital from new investors
Increase public relations efforts

The correct answer is: Allow existing stockholders to maintain their ownership percentage

A rights issue is primarily conducted to allow existing shareholders the opportunity to maintain their ownership percentages in a company when new shares are issued. This is essential for protecting shareholders from dilution of their ownership stakes, which can happen if the company issues additional shares to raise capital. By offering the new shares to existing shareholders first, each shareholder can purchase additional shares in proportion to their current holdings, thereby maintaining their relative ownership and control over the company. While enhancing liquidity or obtaining capital from new investors could be side effects or additional benefits of a rights issue, the fundamental purpose is to ensure that existing shareholders are not disadvantaged by the introduction of new equity. As such, option B provides the most accurate reflection of the primary motivation behind a rights issue. It emphasizes the importance of safeguarding the interests of current investors in the face of new financing activities.