Pre-Emptive Rights – A Theoretical and Empirical Examination

The premise for protecting shareholders from dilution, a loss of wealth and control through providing pre-emptive rights, is that agents may not act in the interests of principals. Proponents of pre-emptive rights emphasize protecting the democratic nature of the limited liability corporation while opponents argue that professional management have greater insights regarding capital formation and growth opportunities. From a financial theory perspective, the argument for protection rests upon whether the costs of debt and of equity reflect capital structure as well as the potential for changes, as ultimately reflected in share prices. Applying financial theory and statistical analysis, we explore if shareholders need protection from dilution, or if the risks are already capitalised into share prices. Our findings and insights cast doubt on the benefits of such protection and the legal basis for compensation.