S. Murlidharan

Too much faith is being placed on price discovery, says S. Murlidharan

NOBODY, save the esoteric tribe of qualified institutional investors (QIIs), more particularly foreign institutional investors (FIIs), seems to be happy with the extant book-building regime whose main plank is transparent discovery of price at which shares are to be issued. Indian financial institutions (FIs) are peeved because merchant bankers for some curious reasons give preference to FIIs in giving firm allotment under the book-building regime.

Retail investors, for whom 35 per cent of the issue is reserved against the earlier norm of 25 per cent, have no choice but to follow the footsteps of QIIs, no matter what the price is, if at all they want to lay their hands on good scrip. The Securities and Exchange Board of India seems to be having touching faith in QIIs when it allows them to bid for shares in the book-building exercise without placing any money upfront which the retail investors have to.

QIIs have the reputation of not reneging on their commitments and, hence, this waiver seems to be the implied argument in their favour. It is wrong to make a sweeping generalisation like this. What would happen if one of them chickens out after having ramped up the price in the book-building exercise? There is no reason why at least a bank guarantee cannot be issued to the company making the public issue by QIIs for an amount equal to the proposed investment promised. After all, bank guarantees do not involve any huge financial outgo except for the small guarantee commission payable to the bank for sticking its neck out.

SEBI owes an explanation to the retail investors, who are supposed to place complete reliance both on the gut feeling and competence of QIIs when it comes to the price of the share, as to how the whole exercise can be called a price discovery mechanism when QIIs are asked to bid within a narrow band.

For example, DTV may come out with an IPO inviting QIIs to participate in the book-building exercise in the price range of Rs 65 to Rs 69 per share. This then begs the question: How in the first place was the band of Rs 65-69 discovered? And if the answer is the company in league with the merchant banker had done this, then the subsequent farce should not be termed a price discovery mechanism because the substantive price has already been discovered in the run-up to the so-called book-building exercise, with QIIs only fine-tuning within a narrow band the price already discovered.

If SEBI has so much faith in the price discovery prowess of QIIs it should dispense with the prescription of price band and ask them to bid at the price they deem right in the light of the financials and other relevant factors.

The other possible means of protecting the retail investors from the risk of high-pitched price fixation is to break them free from the shadows of their more resourceful institutional counterparts. The issue to retail investors can be done after testing the waters in the secondary market for a decent length of time, say, three months following the listing of the shares.

Issue to retail investors may be done, say, at a suitable discount to the average price during the last three months to allow for the likely dilution in the worth of the share consequent upon the enlargement of the equity base which the subsequent issue to retail investors would entail. The company cannot possibly have any grievance against this regime.

Of course this would call for suitable amendments to the company law which otherwise in the circumstances calls for the special resolution of QIIs and other shareholders because the subsequent exercise, strictly speaking, would be a rights issue.

This option seems to be infinitely better than the existing regime under which often retail investors have to reap the bitter harvest of the seeds sown by QIIs. Moreover, the real price discovery, if at all, takes place in the secondary market over a reasonable length of time and not in the primary market. In other words, the retail investors should not be exposed to the vagaries of the primary market.

Instead they should be allowed entry once the waters have been tested in the bourses. QIIs which effectively get a firm and preferential allotment should pay a price for this preferential treatment. As it is, the unfortunate retailers are dragged into the quagmire along with QIIs. It is true that they have benefited from under-pricing of shares in the past but this can be no ground for putting them in the same league as QIIs. Nobody can seriously contend that the appetite for risk for the two is the same.

There is another farce that must be ended pronto. As it is, book building is done even for rights issue. This is clearly unnecessary given the fact that the shares are already listed and the market sheds a better light on the pricing of the issue than a handful of QIIs.

(The author is a Delhi-based chartered accountant.)

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