The Hindu Business Line : Reining in the primary market

A company's project is still on the drawing board. Yet, it walks away with a sizeable premium from the investors in its IPO. Another company, by its own admission, would go on stream only in a couple of years but has the gumption to ask for a sizeable premium and gets it.

Investors in the primary market, which as it is includes 35 per cent from the small-investor category — if retail investors can be termed that — effectively double as venture capitalists without their knowing.

In the US, a company which does not have a track record of profits, cannot access public funds but has to rely upon venture capitalists to a great extent for equity support.

We, however, have been one up on the US itself in this regard. IPOs have thus become the easiest and quickest get-rich-quick scheme for those on the fast-track imbued with vaulting ambitions.

Ushering in discipline

The Securities and Exchange Board of India is toying with the idea of ushering in an optional regime of rating IPOs. This it must do forthwith. Only, it should not be optional but mandatory. This will be an excellent bulwark against the empty boasts of promoters which, coupled with glossing over of real risk factors with the concomitant highlighting of frivolous ones, often characterise IPOs.

Second, the government should pioneer the concept of interest or user charges on the premium part of the equity capital. It is all well to contend that investors in equity cannot be expected to earn fixed returns. But a moment's reflection would show that companies laugh all their way to bank, thanks to the hands-off policy of the government with regard to premium.

A mandatory interest of, say, 10 per cent on premium would have a chastening effect on them, besides giving the investors some reward on a part — which these days is sizeable given the fact that the premium invariably is several times the face value — of their investments.

A user charge always has a disciplining effect in every walk of life — be it use of water or electricity or for that matter capital. It is all fine, once again, to contend that investors in equity should collect their rewards from the market. While the exit opportunity indeed should be provided by the market, it doesn't mean the company, which lays its hand on huge capital, should be left severely alone.

Reservation for retail investors

A suggestion doing the rounds these days in the aftermath of the demat scam, which was inextricably linked to IPOs, is that SEBI should do away with the reservation for retail investors. This suggestion may be heeded only if the institutional investors are prepared to don the robes of venture capitalists and agree to bide their time before booking their profits, besides agreeing to subject themselves to other disciplines that characterise venture capital financing.

Under the present regime, the institutional investors participate in the book-building exercise with an eye on quick bucks.

This seminal change would of course have the effect of reducing book building to a price discovery exercise sans IPO. So what? It would keep away small investors away from projects, which are yet to see the light of the day. And incidentally it would also have the effect of emulating, for once, a sensible US law — not casting small investors to wolves.

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