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Thursday, Jan 08, 2004

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Blocks in the building task

S. Murlidharan

S. Murlidharan looks at the glitches in the book-building regime

BOOK building has been hailed as ideal for price discovery by the Indian financial press in general. It is supposed to be transparent and market driven. But the truth is, the main plank of book building — price discovery — is a casualty in a regime where the company is allowed to introduce the red herring of floor price.

The term `red-herring prospectus', a prospectus issued to the participants in the book-building exercise containing all the details which a full-fledged prospectus must sans the issue price but with a mention of the floor price, is thus wickedly appropriate. For, it sends the participants on the wrong trail. Where is the price discovery when the entire exercise is put into a straitjacket of floor price?

Mercifully, the earlier practice of prescribing the price band within which the participants had to bid has been given up, as that subverted the price discovery exercise even more. As it is, the issuing company in league with the merchant banker works out the floor price. Often this price turns out to be outrageous in the context of the company's current financial performance. Perhaps Maruti's IPO was an exception in hindsight. And the reason is not far to seek. Maruti, with a substantial government ownership, was not possessed by the overarching fly-by-night and/or predatory tendencies, which characterised its predecessors in the IPO market.

The floor price cramps the participants in the book-building exercise. They are somehow led to believe that there is something sacrosanct about the floor price and, therefore, they only get limited elbowroom in determining the price. Will SEBI allow the participants to truly discover the price by prohibiting the unleashing of the red herring of floor price?

The apologists of the extant regime may counter this by saying that in every auction, the seller fixes the floor price and bidders cannot demur. Well, two wrongs cannot make a right.

Moreover, as it is, there is no commitment on the part of the participants to honour their offer to take a given number of shares. They can always back out. Should not greater seriousness be imparted to the entire exercise by requiring the participants to place, say, 10 per cent of the bid amount in an escrow account to be adjusted against the final allotment.

Needless to say, the amount should be meant to be forfeited should the participant renege on his promise. Lack of commitment on the part of the participants has a mischief potential — to manipulate the entire exercise.

The extant book-building regime smacks of preferential allotment and private placement rolled into one. Accent on book building robs public issues of mass investor participation as in a 100 per cent book building where the lion's share is cornered by the participants in book building. In the context of privatisation and disinvestment, the suggestion gratuitously made in some quarters that the Government unload its holdings in public sector companies through the book-building route is dangerous. If the Government wants the public to partake of the prosperity assiduously built by public sector companies, book building should not be an option at all because book building by its very nature would result in cornering of shares by qualified institutional investors and high net worth individuals leaving small investors the crumbs.

At any rate, when share market quotations are available, there is no need to discover price through the book-building process (ONGC and GAIL are already listed companies).

The Government can easily fix the offer price with reference to the market quotations obtaining in the run-up to the disinvestment.

Book building, warts and all, could be an option for the private sector but not in the context of public sector disinvestment inasmuch as what was built with taxpayers' money ought to go back to them. In the event, the accent should be on allotting as many shares as possible to the small investor. Book building stands in the way of achieving this.

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