Outlook: The price of cheap right issues

What's this? A rights issue at half the normal cost? Obviously the City's unique and arcane system for raising equity capital is capable of adapting to the new low cost environment of the late 1990s after all. That, at least, was the way Schroders was billing yesterday's pounds 123m rights issue from Berkeley, the house builder. Normally the upfront costs of raising capital in this way work out at about 2 per cent of the sum raised. By making subunderwriters tender for the business, Schroders reduced this by a half to 1 per cent. Sub-underwriters got only 0.3 per cent, compared with the usual 1.25 per cent.

Actually, this was not quite the innovation that Schroders was boasting of yesterday. A few nobs and whistles have been added, but this is essentially the same formula used by Schroders and others last year in an attempt to see off repeated threats by John Bridgeman, director-general of fair trading, to refer the City's underwriting cartel to the Monopolies and Mergers Commission. By arranging the subunderwriting in this way, Schroders can claim, with some justification, that the cartel no longer exists.

Mr Bridgeman's concerns about the existence of a "complex monopoly" have been answered, the cost of raising capital to British industry has been lowered, and jealously guarded pre-emption rights have been preserved, all at the same time. Brilliant.

Unfortunately it is not quite like this. Cost of capital is a many-headed monster and it is by no means clear that what Schroders is doing here is much of an advance. In essence Schroders has used the Berkeley issue to test the extent to which investors will accept lower commission because a wider discount reduces their underwriting risk. By plumping for a wide discount to the prevailing share price of around twice the usual level, the cost to Berkeley of raising its money was reduced by around 50 per cent. However, the long-term costs to the company of this capital have probably been greatly increased.

This is because investors will continue to expect the same rate of dividend on the new shares, even though they are being issued at a discount of a quarter to the prevailing stock market price. The effect of widening the discount is correspondingly to increase the ongoing costs of the capital.

Companies would probably be better off issuing shares at a large enough discount to have done with the underwriters altogether, and then persuading the institutions that they should accept a cut in the dividend to compensate for the discount. Or perhaps they should simply adopt the American bookbuilding model and accept that rich bankers are the price for tight discounts. Either way, Mr Bridgeman shouldn't flinch from referring the present system to the Monopolies and Mergers Commission.