I had something to do with the creation of SEBI when I was in the finance ministry; my idea was to transfer capital market regulation from the ministry to a professional regulator. But if I had had an inkling of what it would become, I would never have let it be born. With its fondness for the oligopoly of qualified institutional investors and risk aversion, it has killed the risk capital market and curbed market competition. It is one of the prime causes for India's poor industrial growth.
Otiose distinctions
The public issue of Tata
consultancy Services attracted half a million applications from “retail”
investors. The Oil and Natural Gas Corporation issue attracted 567,000. The
NTPC issue attracted 14.1 million. Seeing their response, the Securities and
Exchange Board of India (SEBI) has increased their quota in public issues from
25 to 35 per cent. It also redefined retail investors as those whose
application was under Rs 100,000 instead Rs 50,000.
These investors are an ancient
tribe; once they used to be known as small investors. They used to swarm in
thousands around such speculative issues as those of Reliance in the 1980s.
There was a special reason for this. The Controller of Capital Issues used to
fix prices of public issues; he based the prices on past profits of companies,
and thus underpriced shares of companies expected to better in the future. So
investors could confidently expect that the market price of the shares, once
they were listed, would be far above the issue price; in other words, an
investor could multiply money within a few weeks if he got an allotment.
Naturally, investors applied for more shares than were to be issued. So the
government imposed rationing: no one could get more than a certain number of
shares. To increase their allotment, investors made multiple small
applications. These makers of multiple applications were christened small
investors. They were in a lucrative business; vested interests grew up around
it. Politicians would bat for them and protect their interest. That is how they
came to be deified.
This business of easy money
should have died when, in 1992, the government abolished the controller of
capital issues and abolished issue price fixation. But in the great stock
market boom of the early 1990s, too much money was chasing too few issues. The
market price of some shares climbed immediately after public issue. That kept
“small” investors applying; and ever sensitive to political advantage, SEBI
created a quota for them.
Now that the stock market is
booming, small investors are again being attracted to it. SEBI has made it so
difficult to make a public issue that only rock-solid companies are able to
make one. Because there are so few, they are being oversubscribed. And – most
important – listing at a premium has returned. That means automatic profit for
an allottee, and the return of multiple applications. SEBI encourages them by
keeping a part of the allotment for “retail” investors.
The strike price of issues is
fixed by book-building, which is a kind of auction; if the auction were
perfect, the issue would not go into a premium on listing. Here, SEBI
introduces systematic imperfection. The quotas for different investors mean
that their chance of getting an allotment depends on the caste they belong to;
the highest bidder cannot be sure of getting an allotment, so highest bidders
do not bid. When the finance ministry abolished control of issue prices, it
meant to abolish profits arising from underpricing. SEBI has brought them back
through the back door.
Today’s paperless trading ensures
that in theory, a subscriber could apply for even one share at a price of his
choice. The strike price is decided in such a way that anyone who bid more than
it would get an allotment even if he applied for only one share. So small
investors could get allotment today without any special arrangements for them.
The rationing system set up by SEBI only panders to a political lobby, and
brings profits to multiple applicants at the expense of the issuing company. As
it is, there are too few public issues; the underpricing SEBI imposes on them
raises the cost of capital to companies and reduces public issues even further.
Instead of pandering to the
mythical small investor, SEBI should allow experiments in the auctioning of public
issues. Auction theory is a live area in economics, and many experiments are
being tried out round the world; the Google public issue was the latest amongst
them. Let India too be a laboratory.
Instead of creating an oligopoly
of so-called qualified institutional investors, SEBI should define such
qualifications for public issue applicants that the smallest individual
investor can easily and confidently take part in an issue auction. It has
already given every investor a code. Now it needs to create a mechanism by
which investors can apply for an issue without locking up their investment: it
would involve an automatic debit to their bank accounts at the same time as
they are allotted shares. For all its perfection, the Indian stock market
raises little money for companies, and none for new and small companies. It is
this failure to which SEBI should apply its attention.
