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April 15 - 21, 2002

Once a public company has decided to issue further share capital, it has to decide a subscription price. The shares can be issued at par, premium, or discount. The typical par in Pakistan is Rs 10, therefore, a company can issue shares at Rs 10, above Rs 10, or below Rs 10. When its share is selling below par in the market, the issuer would have to consider offering them below par, i.e., at a discount, otherwise shareholders would be unlikely to subscribe. The objective here is to discuss some of the issues involved in the rate of discount on further issue of shares.


Public companies are allowed to issue shares at a discount from par under section 84 of the Companies Ordinance 1984 but only after fulfilling some legal requirements. There are two scenarios:

i. If the discount rate is 10% of par or less, then issuer first takes the approval from its shareholders by means of a special resolution in a general meeting and then takes the approval from Securities & Exchange Commission of Pakistan (SECP).

ii. If the discount rate is more than 10% of par, then the issuer first takes the approval from SECP and then from its shareholders.

Some key questions need to be answered in a discount issue:

  • Should discounts on par be allowed?

  • How to determine the rate of discount?

  • Who should determine the rate of discount?



Whether or not discount should be allowed depends on the purpose and nature of the issue.


Where a company is issuing shares to meet capital adequacy requirements, discounts would go against the very purpose of increasing capital. If left entirely to the issuers, it is likely that they would try to issue shares at maximum discount to minimize additional investment. Recently SBP has increased the minimum paid-up capital, including unencumbered general reserves, for an investment bank to Rs 500 million. Similarly, SECP has raised the minimum capital requirement for leasing companies to Rs 200 million. If these companies issue shares at a deep discount, say 90%, it would mean that the company would pay in only Rs 1 to increase its paid-up capital by Rs 10 and the purpose of enhancing the capital requirements would be defeated.


If shares are offered below the market price without right offer, then it would be transfer of wealth from existing to new shareholders. A company can issue shares without rights under Section 86 of the Companies Ordinance 1984, however, first the issue must be approved by the shareholders by means of a special resolution and second, the issue must be approved by SECP. The issuer would have to justify to SECP that the issue is in the interest of the shareholders. Due to these twin approvals, this door of manipulation is closed.


Say a company issues 10 million shares with a par of Rs 10 at a subscription price of Rs 5. This would increase the company's cash by Rs 50 million but Paid-up Capital by Rs 100 million. The difference of Rs 50 million would be amortized over five years at Rs 10 million each. The amortization expense would be reported on the income statement but it would not be tax deductible. The amount to be amortized would appear in Deferred Costs on the Balance Sheet. Unless the company's profits offset the amortization expense, it would add to the losses and reduce the reserves.


Before the Issue
After the Issue

Cash: 100
Others: 500
Cash: 150
Others: 500

Other Assets: 900
Paid-up Capital: 500
Deferred Cost: 50

Tot: 1,000
Tot: 1,000
Other Assets: 900
Paid-up Capital: 600

Tot: 1,100
Tot: 1,100


The discount may be manipulated by some to enhance their shareholding and control in a company. For instance, shares of an issuer selling at Rs 5 might be issued at a par of Rs 10, with the directors or sponsors underwriting the issue. It is only likely that common shareholders would not exercise the right to buy these shares and they would be picked by the directors. By not giving a discount, directors can make an issue unattractive for other shareholders.


If a share is selling at par, some discount might be necessary to make the issue attractive for the shareholders. Shareholders might not be interested in buying something for Rs 10 that is selling for Rs 10. They might have better investment opportunities, they also might not have cash enough at that point in time to invest in rights, and so on. A discount of a few rupees might just be the solution to make the shareholders interested.


Economically speaking, the rate of discount depends on three things:

  • Share price before the issue

  • Expected share price after the issue

  • How representative the share price is of the true value


For a share selling at Rs 5, would you be willing to buy it at Rs 10? Not really and nor would a common shareholder. Clearly, a discount rate should consider the market price when the share is trading below par. However, no less important is the expected price with the issue.


Expectations would determine the market reaction to the share price. There is a long lag time involved when shareholders receive their right shares and the company receives the proceeds. However, the market would start reacting when the information in the issue is made public which is usually when the notice of the general meeting with the relevant resolution appears in the newspapers. The market would revise the price of the share based on its own expectations of the financial performance of the issuer after the issue. Theoretically, share price should stay the same if the Net Present Value (NPV) of the purpose for which new shares are issued is zero. It should increase if the NPV is positive and vice versa.

For the shareholders, buying new shares would be worthwhile if the share price after the issue increases enough so that the gain on existing shares offsets the premium paid over the market price on the new shares. Interestingly, the expectations on share price after the issue also depend on the mode of financing. Management, that knows more about its financial prospects than others, is likely to issue debt when things are looking good because leverage makes good times better and bad times worse. This is why an equity issue is generally considered an unfavourable signal of future prospects, which should decrease the share price. In Paksitan, one can question whether shares prices are determined by market as they should be.


For large capitalization frequently traded stocks, the weak form market efficiency that all publicly available information is incorporated in the prevailing market price is likely to hold and market price would be a workable estimate of the true value of the stock. But this may apply to only a few companies in Pakistan. There are 743 companies currently listed at KSE but 95% of the trading takes place in 3% of the shares. Many stocks have a very small free float on the market and they are very thinly traded, if traded at all. It is hard to say that their prices are a true reflection of their intrinsic value based on publicly available information. Table 1 gives a few examples of shares selling below par in different industries in which the share price did not budge a paisa throughout the year.

Table 1: Some shares with a constant price in 2001


Share price

Jan-Dec 2001

UDL Industries


Libaas Textile


Javedan Cement


Escorts Investment Bank


Lafayette Industries Synthetics Ltd


United Insurance


Climax Engineering


Source: KSE Daily Quotations, 2002

Past precedents show that companies whose share price is unlikely to represent the true value of share are more likely than others to need the discounts. Determining a discount rate for such companies and for unlisted public companies would need be based on estimated fair price determined by techniques like discounted cash flow analysis.


The directors have a vested interest in the viability of the company because in case the company gets into financial difficulties, they stand to lose not only their investment but also their jobs, perks, privileges, social status, contacts and so on. Often the latter are of greater value to them than the former and they usually are more willing to buy the shares above the market price. Therefore, all shareholders ought to have a say in the discount.


Recently Fauji Cement has used an interesting rule for determining the discount on an issue without right. The rule was that the subscription price would be determined such that the percentage discount from par would be equal to the percentage premium over average market price. The market price used was the trading volume weighted average closing price of the last ten trading days prior to the general meeting in which Fauji Cement obtained the approval of its shareholders to the issue. Based on this formula, if the average market price is Rs 6, then the subscription price would be Rs 7.5 because Rs 7.5 is 25% above Rs 6 and 25% below Rs 10. This rule can also be modified such that instead of percentage discount, the absolute Rs discount form par would equal the absolute Rs premium over average market price. If the market price is Rs 6, then subscription price would be Rs 8 because it is Rs 2 below par and Rs 2 above market price. The absolute version would lead to higher subscription prices than the relative version, therefore, it is likely that the existing shareholders would prefer the latter. The market price can be averaged over different periods in different ways to suit the situation. One cannot term these formula based discounts objective but making the subscription price a function of market price yet to be determined does reduce the subjectivity involved. This can be particularly useful in reaching an agreement for discounts on other than right issues.


One of the reasons behind SECP's approval of the discount is that while passing a special resolution requires at least 75% of votes in favour, the minimum quorum for a general meeting is only 25%, therefore, a special resolution can be passed with shareholding ranging from 18.75% to 75% or more. That is, it is possible to pass a special resolution in favour of a discount when it is not representative of the will of the majority. The question that who should determine the rate of discount depends on why the shares are being issued and what is the potential of abuse in the issue. If the issue is of right shares and the shares are being issued for purposes other than meeting the capital adequacy requirements, then the decision should not be of the regulator. After all, it is shareholders' money and shareholder's company.

Some recent cases of a discount


Subscrip- tion price


Pak-Gulf Leasing Company Limited

Rs 7.0


Lafayette Industries Synthetics Limited

Rs 5.0


Sigma Leasing Corporation

Rs 7.0


Network Leasing Corporation

Rs 7.0


Prudential Commercial Bank Limited

Rs 7.5



Determining the appropriate rate of discount from par might be tricky but it is best left to the shareholders. The role of government and regulators should be to promote disclosure, accountability, and competition rather than approve specific business decisions for shareholders. It would not be unreasonable to say that discounts on par should be regulated only when deregulation has substantial likelihood of abuse.



i. If shares are being issued for purposes other than meeting capital adequacy and are with a right offer, then the decision should be entirely of the shareholder's to be taken by means of a special resolution.

ii. No discount should be allowed until a company has met its capital adequacy requirement. Exceptions to be decided by SECP.

iii. Discount on issue without right offer should be approved by SECP and formulas should be used in such cases, whenever possible.

iv. Directors and sponsors should not underwrite any right issue without shareholders' and SECP's prior approval.