Jayant Thakur: Is stock delisting gaining ground?

Stringent Sebi norms and the entry of large investors are pushing companies off the bourses.

The ongoing boom in stock markets reveals a regulatory paradox and one has to see whether it would be full blown or would it stabilise. As one force brings more and more retail investors in the market, another force seeks to drive them out. Succinctly, it appears that the sheer market demand of shares of listed companies is sowing the seeds of its own destruction. This trend is being observed not just in India but the world over. Ironically, steps by the Securities and Exchange Board of India (Sebi) seeking to ensure good governance and transparent delisting are only further helping to aggravate this.

This phenomenal demand for shares of companies has resulted in more and more investors chasing the existing limited stock. The prices have thus gone higher and higher. Many retail investors have exited by profiting from sale or have generally avoided further purchase. Thus, the number of retail investors has reduced as one part of this trend.

The other is the entry of wholesale investors who seek to buy in bulk, and preferably from the company itself or, at times, from the promoters. Important amongst these are private equity investors whose size in billions of dollars has only increased. These investors are buying in bulk. Since such acquisitions are made typically through preferential allotment, there is no simultaneous offer to public or retail shareholders.

Even publicly held bulk investors are joining the fray. For instance, Temasek has invested huge amounts of funds in Indian companies. The proposal by the Indian government to set up a similar fund can only push this trend to extremes.

The result is a sheer paradox. The stock markets are mainly intended for small and large investors to freely trade in and if the shareholders finally are just a few in number, with significant shareholding, the purpose of listing is probably lost. One may recollect that Sebi had once sought to enforce a requirement that companies should have a certain minimum number of shareholders related to the size of its share capital. The requirement was dropped but the principle still remains.

One could argue that, for large investors, there would be a need of listing since they would want to eventually sell their shares and finally only small investors would buy the shares. However, it appears that this is not necessarily the case, and such large investors may be willing to exit, say, through buyback of shares, sale to promoters, to other investors, and so on.

Will, then, more and more companies delist their shares from stock exchanges? It appears that some of the significant advantages of listing are being lost. As against that, some disadvantages of listing are being aggravated.

Post Enron, for instance, the requirements of corporate governance and otherwise have further increased. The costs of compliance of these and other requirements of listing are increasing and so are the risks. It must be accepted that many of these are token and superficial in nature and thus add to the costs without adding value. The fact that Sebi now has powers to levy penalty in crores for elementary and unintended violations adds to the deterrents to continued listing. For India, the mindless aping of western corporate governance concepts, where those in management hold miniscule shares, creates even greater problems without any benefits. And even apart from the requirements of corporate governance, the other requirements of maintaining investor relations, disclosures and compliance of listing, all add to the efforts and costs.

Sebi, interestingly, is tackling the matter in at least two ways. It does not appear to be comfortable with the idea that large investors with heavy bargaining power are acquiring shares to the exclusion of small investors. Unlike small investors, such large investors can negotiate special rights and often enter into agreements with the promoters and the company for preferential treatment. Shareholders' agreements are very common and rights include significant and special rights. While most such investors may not be interested in sharing the management in detail, they do wish that their approval be taken or they be consulted on all material matters. Almost as a rule, they have one or more of their representatives on the company board. Sebi would rightly frown at such arrangements since small investors would get further marginalised. Rightly so, then, such arrangements and agreements are being scrutinised and in appropriate cases, it may be held that such large investors would be deemed to be part of the promoters themselves.

Sebi is also making its norms for minimum public holding stricter. By a recent amendment to the Listing Agreement, Sebi has plugged many loopholes which enabled companies to have very low public holding and still be listed. The amendments now give a deadline by which companies have either to increase their public shareholding or quit the stock exchanges. I will not, however, be surprised if many companies will choose to happily delist and quit.

What then would happen to the small investors in companies where their holding is very small or which propose to be delisted? Till now, the requirements were full of loopholes. However, many recent developments have changed the situation. For instance, earlier, it was possible for promoters to buy back the shares at any price deemed fit in the course of delisting. The shareholders fearing delisting and thus effectively no market for their shares may sell them at such low price offered. Sebi now seeks to require that such buyback will only be at a market price plus a premium of 25 per cent or at fair value plus such premium. This makes a lot of sense and should give a fair exit to outside investors.

The government is also in the process of issuing guidelines for delisting. While, in one sense, it is feared that this may create overlap and contradiction, it is perhaps a pointer that delisting is becoming more acceptable.

The proverbial stage is thus set for more and more companies to be delisted. Let us see whether and to what extent does this really happen. This should not be as shocking as it would initially appear. One would recollect that non-banking financial companies were also subjected to stringent regulation and the numbers reduced from more than 50,000 in 1997 to just 500 or so now.

At the same time, delisting may not be in the interests of all concerned in the long run. And I am not talking of parties having vested interests such as brokers, merchant bankers, and so on, who make their earnings through stock markets or even the regulators who exist on account of such markets. But companies would lose the lucrative huge numerical quantity of small shareholders who would be willing to pay a higher price generally and are comparatively less demanding in terms of rights. Large investors themselves would be happy to have such small investors around for the same reason, and in any case, for the need of having an active stock market where they can offload their shareholding from time to time.

Thus, then, in the interests of all concerned, it may be worth encouraging the continuance of listing. This is becoming increasingly difficult though one hopes that this eventually prevails.

The author is a chartered accountant.