394 CORPORATION FINANCE
holder the right to subscribe to any new stock that the corporation may
wish to sell.
"\Vhile the right to subscribe to new stock is granted to stockholders on a
prorata basis, stockholders are sometimes invited to bid for shares not
absorbed by other stockholders. In 1936, stockholders of the Franklin
Rayon Corp. were offered rights to subscribe for new stock. Each stock-
holder was permitted to subscribe for as many shares as he desired. The
total issue of new common stock amounted to 10,000 shares. It was
announced that, in case of oversubscription, allotments would be made in
proportion to subscriptions. In offering new stock at §20 per share in the
ratio of one new share for each five held, the Harshaw Chemical Co. per-
mitted its shareholders to apply for additional shares at $20 each. The right
to subscribe for the regularly allotted shares in the ratio of one to five was
transferable, while the privilege of subscribing for extra shares was not.
Preemptive Rights.—At common law, stockholders have the right to
subscribe pro rata for new stock issued by the corporation. The justification
for this rule is that only by subscribing for new stock in proportion to the
amount already held can a stockholder retain his voting position and his
share in the surplus where the new stock is offered below the current value
of outstanding stock. For example, suppose a corporation with 1,000 shares
of $100 par stock has a surplus of $50,000. If A owns 100 shares, he has a
claim against $5,000 of the surplus and the right to vote 10 per cent of the
voting stock. If the corporation issued 1,000 new shares of stock at $100
each and if A purchased none of them, he would then have a right to vote
only 5 per cent of the resulting stock and his share of the surplus would be
reduced to $2,500. This example assumes that the usual practice is followed
of offering a privileged subscription at a price considerably lower than the
market price of the stock. In order to maintain the preemptive rights of
the stockholders, it is not necessary to offer stock to them at less than could
be obtained from outsiders.
Preemptive rights do not apply to the following cases of stock issue: In
the original issue of stock, there are no rights to control established and
presumably there is no surplus. Hence the stock may be offered to any one
interested in its purchase. Just what constitutes an "original" issue may be
open to dispute. If, for instance, 50,000 shares were originally offered but
only 30,000 sold at the time and the remainder was not sold for a couple of
years, questions might be raised .whether the second installment did not
constitute a new issue. Treasury stock is not ordinarily subject to pre-
emptive rights. Such stock is considered to be an asset of the corporation,
to be disposed of to such buyers as the corporation may see fit to select.
Stock exchanged for property need not first be offered to the stockholders.
Tie law recognizes tfce right of the corporate management to make an
exchange of stock for property without first consulting the stockholders.