Sucheta Dalal :A VRS solution for investors (19 August 2002)
Sucheta Dalal

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A VRS solution for investors (19 August 2002)  

If investors had their way, they would vote to disallow delisting of companies. Statistics show that the 12 companies that went private in the late 1990s started a trend. In 2000-2001, 21 companies, almost all of them MNCs went private and in 2002, five more opted out. Prime Database tells us that in addition to these 38, another 90 companies plan to delist from Indian bourses. The large number of companies opting to go private indicates that they neither want retail investors nor their money—they also want to do away with public scrutiny.

Since most companies seeking to delist are MNCs who are profitable, pay regular dividends and are reputed to follow better corporate governance standards, their exodus rattled Indian investors. They worried at the dwindling investment opportunities in a scam-ridden market where even large mutual funds such as UTI could not be trusted. The fact that companies used a combination of regulations to mop up their shares, reduce floating stock and then delist their shares left investors feeling cheated. Investors complained the exit price was unfair, but tendered their shares for fear of ending up with illiquid holdings in delisted companies. Naturally, investors want the delisting to stop. At the very least, they wanted the regulator to create disincentives to delisting.

When the finance ministry also expressed concern at the possible negative impact of delisting, Sebi set up a committee to come up with some answers. The committee said that blocking companies from delisting their shares was inimical to the concept of a free market. Yet, there was a need to regulate the exits through a clear delisting mechanism. The question was: should the exit offer be formula-based, or allow shareholders to determine the price through a transparent price-discovery mechanism? Since it was evident that delisting would occur mainly in a depressed market when prices were already low, it made sense to opt for a price-discovery mechanism. One view was that just as employees get a voluntary retirement package to quit their jobs, an investor too deserves a premium for giving back his/her shares. A majority decision of the committee opted for ‘reverse book building’ because it would make investors the decision-makers.

The logic was simple. If book building was considered a good price discovery mechanism for listing shares through an IPO, even when it was open to the larger universe of investors, it ought to work even better in case of delisting. The reverse book-building route would operate in a controlled group of existing shareholders who know the company well. Additionally the 26-week average price as a floor would ensure a minimum fair price. The procedure also eliminates extreme bids since the offer price would be that which a majority of shareholder would bid. If companies find the price determined through book building too high, they have the option of rejecting the bid and remain listed.

The CII dissented against the decision and objected to reverse book building. Its representative claimed that shareholders would manipulate the process and reduce its efficacy in a limited universe. One would have expected that such manipulation would only lead to unrealistically high bids, but the CII curiously argues both positions. On the one hand its representative claims that investors can ‘derail’ the delisting process through ‘manipulative bidding at unrealistic high prices’. At the same time, he also insists that shareholder with ‘no indication of the buyer’s intention’ other than the 26-week minimum bench mark, could end up bidding low and may lose out on a higher price that an occasionally generous buyer may have been willing to pay.

CII also dislikes the fact that a bid can fail if the company rejects the final bid. It brandishes the same old threat that companies would prefer to float 100 per cent subsidiaries and destroy the value of their listed companies. So what does the CII think is a workable proposition? Simple. Fix a minimum benchmark (either a 26 week or 52 week average) and let the company to dictate the price. It is take-it-or-leave-it. If the investor gets lucky and the company feels generous, it may throw in a premium over the minimum price. But it is hard to believe that companies will pay more, unless they have to.

If CII fears that their small co-owners who are being given the boot would manipulate bids, then international corporate scandals indicate that companies could also play dirty. They are just as likely to manipulate prices downwards to lower the minimum price. But the moot question is, will the reverse book building mechanism allow more efficient price discovery and ensure investors a fair exit price; or will it not? The truth is: nobody knows. Until we experiment with the process, there is no way of knowing whether investors are mature enough to bargain a good deal for themselves or get a lower price. Also, since the bidders will comprise retail investors as well as institutional investors and mutual funds etc. it seems safe to assume that institutional investors would bid sensibly and influence the final offer. Finally, it is up to investors to get the best price—reverse book building only provides them a mechanism and opportunity to make their decision.

-- Sucheta Dalal