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You are in a new city, in a lane famous for its street food or ‘khau galli’ as Mumbaikars affectionately call these lanes that dot the city. Going to the first one you are drawn to or to one that looks less beaten-up are acceptable ways of choosing where to eat. But the most time-tested way, you will agree, is to go to the stall that’s most crowded. It may not be an efficient option as wait times will be longer, but when it comes to eating food that’s not only cooked with love but also by the sweat of the brow, there’s a certain safety in crowds that we crave.
The lack of information in that market and on the adventure’s outcome on your health, as opposed to little fear in entering a reputed restaurant even when it’s empty, is what makes selling a complex job. Investment bankers know this all too well, just see how retail investors allow themselves to get manipulated in IPOs, when they see a crowd jostling for an allotment and don’t even bother to see what’s on the menu before putting their own application in.
Why do retail investors do this when they can buy shares without the noise in the secondary market. This question is not new and neither are the answers, which can include novelty, listing gains, believing they are entering at the first floor and will hence earn higher returns and market euphoria.
But recent regulatory action against IPO financing brings the issue of oversubscription back into the spotlight. The purpose of these intermediaries that are being investigated appears linked to providing easy funding for IPOs, with practices that can be called anything from sharp, falling in a grey area or even crossing a red line.
While the financiers make easy money, and investors apply for more shares to improve their allotment chances, a key motive is to also give bragging rights to IPOs with surreal oversubscription rates. Then, that elusive creature called ‘grey market premiums’ makes its appearance, trading in some subterranean market apparently or just in the imagination of the issue’s clever intermediaries.
The finale comes in the form of the listing pop, that delivers dazzling returns to a sliver of investors who got a sliver of the shares they applied for. And then a feeding frenzy begins. What happened to earlier IPOs that popped on listing? Do long-term valuations and expected returns justify these prices? These questions are all tossed out of the window.
Since this has been happening over the years and across countries, there’s very little that is going to change. Therefore, the regulators are doing what they can. Which is to chase down entities they regulate, to identify problems that are behind the excesses.
But they are also taking aim at targets that are within range. What if they actually take aim at the whole oversubscription balloon? At present, there’s a range — and a narrow one at that typically — in which investors bid. What if you ensure that the book-building process is more robust? For instance, bid higher if you want an allotment irrespective of which category of investor you belong to. And why should there be an upper cap on the price? Let true price discovery happen. Or if that’s too drastic, after a certain level of oversubscription, reopen bidding to take it to the next range.
The issuer can finally decide how much to leave on the table, but the bubble of celebrations of an issue getting oversubscribed 50 times and then that becoming a gold standard for the next issue deserves to be pricked. If the current system that was meant to give retail investors a fair chance is proving to be a trap instead, isn’t it time to relook at the whole structure of IPOs?
And, while speed of completion of an issue is indeed a good thing for investors, it can be delayed a bit to ensure verification of applications takes place before. And if oversubscriptions fall after this verification, investors can be given a chance to even withdraw from the issue.
The fact that there are issues where investors are applying multiple times, knowing these applications will get rejected eventually, shows the huge signalling value of oversubscription to the issuer, but more importantly for the market.
Ultimately, retail investors should know that they are expected to behave like adults. Just because there’s a crowd in an IPO does not mean that it’s a long term bet or that returns are assured. An individual with a weak stomach may suffer an ordeal despite eating at a crowded stall.
Regulators are stepping up because they fear that, as in past episodes, they will be pulled up for retail investors losing their shirt. And that is the case even if nothing illegal may have happened. This is despite retail investors being warned of the risks of equity investing and froth in IPOs multiple times. While issuers and merchant bankers may crib about the proverbial punch bowl being taken away, there’s no free lunch in the stock market either.
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Ravi Ananthanarayanan
Moneycontrol Pro
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