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Pricing IPOs Right

The government’s intent of setting a price band for initial public offers (IPOs) is misplaced zeal and will be counterproductive

Seventeen years after the abolition of the Controller of Capital Issues (CCI), the Government of India is once more thinking of getting into the business of deciding share prices. Company Affairs Minister Salman Khurshid has said that the government is examining the issue of companies setting IPO prices too high and plans to come out with a set of guidelines on fixing a price band for them.

Apparently, this is a solution to the problem of share prices, in recent IPOs, falling below the issue price. It remains a puzzle to me why this should be a problem. No one is forced to buy into an IPO. If an investor judges the price band to be too high, all he has to do is to sit on his hands and not write a cheque. If he buys stock in an IPO and then discovers that his judgement was wrong, then he must lose money. That’s what a market is all about. In a properly-functioning market, it is just as necessary for bad decisions to lead to losses as it is for good decisions to lead to profits.

Any kind of officially-mandated guidelines on setting share prices will just lead us further into a morass. What will happen when investors make losses even on IPO prices that were set according to official guidelines, as is bound to happen? There will be a clamour for tightening the guidelines because any such rule will give rise to a sense of entitlement to immediate profits from an IPO allotment.

And what will happen when a stock rises too much after an IPO? Isn’t that evidence that the company raised capital at too high a cost?

At the heart of this issue is an old and outdated idea that IPOs are in some way specially intended for the small retail investor as a way of making money without taking any risk. This idea belongs to the CCI days, when capital was raised at administered prices and the government forced most IPOs to be severely underpriced. Those days are gone, and good riddance. IPOs are just a different method of buying stock. They are actually less suitable for the retail investor because typically, the company’s business success is either in the distant future, or it has spent a much shorter time under public scrutiny. The quality of information and analyses available on stocks is actually better in the secondary market.

Instead of trying to create new guidelines for share prices, all the government has to do is to carry out its existing job well. Far more harm is done to investors when poor and misleading information is given out and those who are managing such issues get away with it time and again. It would be way better for existing rules to be actually enforced than new ones created.