Quiet IPOs

Every finance professional who has watched the Indian IPO (initial public offer) market would be acutely conscious of the burst of self-promotion indulged in by firms planning an IPO. The experienced finance professional smells a rat the moment a hitherto unknown firm rockets into prominence with a barrage of press releases, advertising, business deals and unquestioning media coverage. One recent development in this context concerns transactions between unlisted companies and one or more media companies, exchanging shares for advertising space, for this raises inevitable questions about conflict of interest when it comes to editorial treatment of a firm in the run-up to the IPO.

A key idea in the economics of IPOs is that the IPO scamsters don't just steal money from investors. They make life worse for every honest firm, because the investor is often unable to distinguish the scamster from the genuine business. To protect themselves, investors become sceptical about all IPOs, thus giving inferior prices to genuine IPOs as well. This is what leads to the phenomenon of IPO under-pricing, which afflicts numerous countries, including India. IPO scamsters don't just cheat their investors; they contaminate all IPOs. Often enough, the companies may be genuine businesses but seeking a higher issue price than is warranted. Indeed, the recent history of newly listed shares quoting at considerable discounts to the IPO price underscores the extent of the problem.

Direct government meddling in the IPO market will not deliver correctives. Approval of IPO pricing by the erstwhile Controller of Capital Issues went out long ago because the CCI formula always led to under-pricing. Favoured treatment for retail investors is not a systemic solution. Sebi's effort to bring credit rating agencies into "rating" IPOs has some merit, but this will be by definition an imperfect exercise, and there is perhaps no global precedent by which to judge how it will work. The effective solution is to conduct an IPO through a screen-based auction with a large number of participants. The regulator must ensure sound information disclosure, for the company issuing shares and also related-party transactions.

The second issue is about better rules governing the release of information through the media, designed to burnish the issuing company's image and raise its profile. Some of this can be legitimate, but the usual practice is to go overboard with pre-issue publicity, on a scale that the company would not indulge in if it were not about to issue shares. The Sebi chairman has rightly brought this issue to prominence, with the suggestion that firms must be placed in a "shut period" in the run-up to the IPO. The period of silence can be debated, but should be long enough to ensure an absence of "noise" when investors are looking at the hard numbers. Once such a rule is in place, the investing community would be looking at the company without being swayed by a media campaign. Such a framework would do a world of good in getting companies to focus more on their business and real numbers. The entire IPO business will then be cleaner than it has been till now.