How to price IPOs right and separate investing from gambling

Blame not just greed but absence of democratic norms at workplaces for the death of a young chartered accountant from overwork

https://www.thecore.in/opinion/india-ipo-us-fed-rate-cut-ey-work-768610 (The site is not behind a paywall, but you will need to register to read this weekly column that looks back and ahead)

Last week’s biggest development was, indeed, the much-awaited Fed rate cut. The Fed cut the federal fund rate by 50 basis points, to set it at 4.75%-5%. That the Fed chose to bring down the policy rate by 50 basis points, rather than by 25 basis points, the normal instalment of change up or down, let Republican presidential candidate Donald Trump declare that the US economy, after experiencing a bout of high inflation, is now headed for a crash. The Fed explained its action as a pre-emptive move, designed to bring interest rates down to a neutral level, meaning, to a level where the cost of money does not, by itself, hinder or boost growth.

In another development, the government of India initiated “a thorough investigation”, after the sudden death of a young chartered accountant at EY, Anna Sebastian Perayil, and her mother wrote a letter to EY chairman Rajiv Memani, blaming the company’s backbreaking work culture, which deprived young employees of sleep, rest and nutrition. The letter circulated on social media, generating much debate. This comes in the wake of a Goldman Sachs vice-president’s death in Singapore in May, attributed to overwork, and of similar such incidents at high-pressure workplaces around the world in the recent past.

While social media has been quick to blame corporate greed, this gives a free pass to the specific problem of how corporate hierarchy lets managers wield power over their juniors, without such exercise of power being tempered by an individual’s basic rights, even in polities that set much store by their democratic norms and rights in society at large. While unions defend workers’ rights in blue-collar workplaces, office workers lack such organized protection, by and large, except in the case of public sector enterprises. This is something that corporate leadership has to work into their Human Resources policy, to prevent work pressure crossing the limits required by efficient use of employee time, to transgress into the arbitrary exercise of power by managers who exert their authority to indulge their own craving for power, rather than to get work done.

The US Fed rate cut has been anticipated since Fed chairman’s categorical assertion at the Jackson Hole symposium of central bankers that the time is approaching for the Fed to cut rates. This has meant that a rate cut has been priced into market agents’ actions for four weeks. India’s foreign exchange resereves rose by 22% since August 23rd, up till September 13th to touch $689 billion. Portfolio inflows have been positive in the last week as well, adding to liquidity. The result has been to add tempo to the trend of Initial Public Offerings being snapped up indiscriminately, in the expectation of a significant listing premium. The Bajaj Housing Finance issue was oversubscribed nearly 64 times, and listed at a premium of 114.3%. This has been happening not just in the case of large companies with solid managements but also in the case of small companies with no justification for the huge appetite investors have shown for their offerings.

As the Core Report’s Weekend discussion brought out, the trouble is a flawed pricing model for public issues. There is no regulatory input to the pricing of an issue, and it is left to investors to decide whether they should pick up the offering at the price specified, as a band. Merchant banks that advise the issue set the price band, and investors have the option of subscribing at the cut-off price, which, these days, tends to fall at the upper end of the price band.

The sensible thing to do would be to reform the pricing structure. One method is the French auction. In this, the company making the IPO sets a minimum price and invites bids. Depending on the response, the company negotiates a minimum price and a maximum price. Bids above or below these limits are excluded. Shares are then allotted pro-rata among the bidders at the minimum price.

The Dutch auction is even better. Would be subscribers to the issue place bids, indicating the price they are willing to offer, and the quantity they are ready to purchase at the price. The bids are ranked in terms of price. The lowest price at which the entire issue would be sold then becomes the issue price. Bidders get the quantities they bid for, at a uniform price, which, typically, would be lower than the highest price.

In order to bring some much-needed discipline to the Indian market, in which would-be investors have no clue as to the nature of the business or financials of the company whose IPO they want to lap up, a variant of the Dutch auction might be more appropriate.

Investors should bid both the price at which they want to bid and the quantity they wish to buy at that price. Shares should be allocated to the highest bidder for the full quantity bid for. Then, the bidders at the second highest price on offer should be allocated the number of shares those who bid that price wished to buy. This process should continue for the next lower price, and so on, till the entire issue is fully sold. If bidders get what they wish for, they would be more careful about the wish they make.

The company making the IPO should be free to set a minimum price. This would be the extent of the merchant bank’s role in determining the price. Once the facility of bidding at the cut-off price is eliminated, only investors who have the financial savvy to analyse the company’s financials and prospects would be able to make an offer. This would bring down the froth in the IPO market significantly.

This model would put to the test the actual investing savvy of fund managers, analysts and investment advisors, and swiftly eliminate the malign influence of clueless social media influences. A section of the investing public, who have got addicted to the notion that subscribing to IPOs is a legitimate form of gambling, in which those who get share allotments will always have an upside, with no downside risk to the process at all.