Better leave it alone

On the face of it, Sebi's decision to ensure a minimum non-promoter stake of 25 per cent for listed companies sounds like a good idea.

It is intended to increase liquidity and reduce opportunities for sharp operators to ramp up share prices by exploiting a share's perceived scarcity.

But as with all good intentions, the decision is partly misconceived. Quite apart from the fact that many of the companies with low free floats are actually public sector banks and companies, the point is liquidity is not merely a function of non-promoter holdings.

Several other factors are equally important. Among them are the distribution of the non-promoter holding, the willingness of shareholders to actively buy and sell these shares rather than merely buy and hold, and the absolute number (not percentage) of shares available as free float.

Let's take ONGC "" a share in which there is great market interest currently. While it may be a good idea to dilute the government stake in the company for many reasons, even with a 16 per cent non-promoter stake, it gets traded more than Hindustan Lever with a 49 per cent free float.

More than 22 crore shares of ONGC are currently available for trading; if liquidity is an issue, the share could easily be split 1:10 to give you a free float kitty of 220 crore shares.

However, if everyone and his aunt wants to buy and hold ONGC, even a dilution of up to 25 per cent will not be enough to give the market what it wants. This could well happen when pension funds and other longer-term players start buying scrips from the market.

There is, however, a more fundamental reason why it is not a great idea to mandate a minimum level of non-promoter holding: decisions about raising additional capital should arise from the needs of the business.

A dilution of the promoters' stake cannot be achieved without either raising additional capital or forcing them to sell a part of their existing stake.

Very often, companies that are generating great value do not need huge amounts of additional capital: they are able to generate surpluses from operations.

This, for example, is currently the case with most of our top-tier software companies. Why should Sebi decide when and how they should be raising capital? It's also worth recalling that it was Sebi that permitted software and media companies to offer as little as 10 per cent in initial public offers in order to encourage closely held companies to seek a listing.

Does that objective no longer hold good? The bottomline is that in today's fast-changing business environment, a crucial issue like capital raising is not something that should be mandated.

Companies need the flexibility to raise and buy back capital at a time of their choosing because the cost of capital is changing all the time.

Companies that need money may want to raise more capital from the market while still others may not want the distraction of a large body of shareholders at a time when they want to concentrate on building a market by sacrificing margins.

With the price of debt coming down, more companies may want to shift the mix in favour of debt to optimise returns to shareholders.

To force them to raise more share capital when they don't need it is not something Sebi should be concerned about.