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Will govt-determined IPO price bands help investors?

india Updated: Oct 04, 2009 21:07 IST
Dhirendra Kumar

Seventeen years after the abolition of the Controller of Capital Issues (CCI), the Government of India is once more thinking of getting into the business of deciding share prices. Company Affairs Minister Salman Khurshid has said the UPA government is examining the issue of companies setting prices for initial public offerings (IPOs) too high, and plans to come out with a set of guidelines on fixing a price band for IPOs.

Apparently, this is seen as a solution to the problem of the share prices of recent IPOs falling below the issue price. It remains a puzzle to me why this should be a problem. No one is forced to buy into an IPO. If an investor judges the price band to be too high all he has to do is to sit on his hands and not write out a cheque. If he buys stock in an IPO and then discovers that his judgment was wrong, surely he must lose money! That’s what a market is all about.

In a properly-functioning market, it is just as necessary for bad decisions to lead to losses as it is for good decisions to lead to profits.

Any kind of officially-mandated guidelines on setting share prices will just add to the morass. What will happen when investors make losses even on IPOs whose prices are mandated by official guidelines — as is bound to happen? There will be a clamour for tightening the guidelines because any guidelines will give rise to a sense of entitlement to immediate profits from an IPO allotment. And what will happen when a stock rises too much after an IPO? Isn’t that evidence that the company raised capital at too high a cost?

At the heart of this issue is an old and outdated idea that IPOs are a way for the small retail investor to make a profit without any risk. This idea belongs to the CCI days, when capital was raised at administered prices and the government forced most IPOs to be severely underpriced. Those days are gone, and good riddance.

In reality, IPOs are just a different method of buying stock. They are actually less suitable for the retail investor because typically, the company’s business success is either in the distant future, or it has spent a much shorter time in public scrutiny. The quality of information and analyses available on stocks is actually better in the secondary market.

Instead of trying to create new guidelines for share prices, all the government needs to do, is to do its existing job well. Investors suffer far more harm due to poor and misleading information given out. And then, those who manage such issues get away time and again. It would be way better for existing rules to be actually enforced, than new ones created.