Shrinking equity cult and rising uncertainties

M R Mayya

Small investors have received a severe blow by the recent amendment effected to the Securities Contracts (Regulation) Rules, 1957 (SC(R)Rules) by the government reducing the percentage of public offer from 25 per cent to 10 per cent of each class or kind of securities of a company to be eligible for listing on a stock exchange.
The main route for spread of equity cult in India is the primary market as investors, particularly in semi-urban and rural areas, do not have ready access to the secondary market nor the requisite trust in the intermediaries dealing in this market.

The equity cult had received a tremendous setback when the Dividend Restriction Ordinance restricting payment of dividend to 12 per cent of the face value of a share or one-third of the distributable profits of a company, whichever is lower, was promulgated in July 1974. Dilution of foreign shareholdings in the latter half of the 1970s by about 120 FERA (Foreign Exchange Regulation Act) companies making public offers of shares worth about Rs 150 crore with premia fixed as per the valuation guidelines issued under the Capital Issues (Control) Act, 1947 and grant of weightage to applicants in lower categories, particularly those applying for shares up to 200, generating about two million shareholders, however, dramatically altered the face of the Indian equity market.

Activity in the secondary market revived instantly. It may be noted that as per the SCR(Rules), 60 per cent of the equity capital was required to be offered to the Indian public to be entitled for listing till September 20, 1993, when the percentage of public offer was reduced to 25 per cent. Till then, relaxation in percentage of public offer was granted only to those companies that had foreign collaborators or public sector undertakings as co-promoters or foreign companies diluting their alien holdings. Even in all these cases, public offer had normally to be at least 33 1/3 per cent of the issued capital of a company.

The stipulation in the recent amendment effected to the SC(R)Rules that a company availing of the benefit of 10 per cent route should make a public offer of a minimum of 20 lakh securities and the size of the public offer should be a minimum of Rs 100 crore, welcome as it is, has to be viewed in totality. A company with an equity base of, say, Rs 1,000 crore was earlier required to offer Rs 600 crore to the public with weightage in allotment to smaller applicants, while under the new dispensation, the public offer can be just Rs 100 crore.

The story does not end here. It has to be reviewed in the context of the Securities and Exchange Board permitting all public issues through the book-building route. Companies raising capital either through 100 per cent or 75 per cent book-building route need to reserve up to 25 per cent of the issue to individual investors applying up to 10 tradeable lots. This would mean that in respect of a company with an equity capital of Rs 1,000 crore, the public offer can be just Rs 100 crore, with the reservation for individual investors applying up to 10 tradeable lots to the extent of Rs 25 crore.

In other words, the share of individual investors is reduced to 2.5 per cent of the total equity capital of the company against 25 per cent to 30 per cent that normally used to go to small individual investors earlier because of the weightage in allotment. There has already been a sharp diminution in the interest of small investors in the new issues market.

In almost all the recent issues, which had chosen the book-building route, the number of small investments was below 5,000 shares and in some cases even below 1,000 shares, as almost all the individual investors do not have the requisite expertise to participate in the book-building process.

It is relevant to note that the book-building process has not proved to be a good price discovery mechanism as post-listing prices in several cases have ruled well below the offer prices. For example, most of the book-building issues listed in January 2001 are ruling below the offer prices, with a majority of them recording losses of over 50 per cent. The Raison-de-etre for choosing the book-building route itself thus gets knocked down.

The argument of inducing companies not needing additional capital to seek listing advanced in favour of reduction in public offer to 10 per cent does not seem to be based on realities, at least in respect of a majority of them. Promoters do scout for private placement among their friends and relatives with offer of shares either on par or with a lower premium and later offer only 25 per cent or 10 per cent of the capital, as the case may be, to the public with a higher premium.

It needs to be realised that shrinkage in public offer leads automatically to illiquidity of the scrip in the secondary market. This is particularly so when bulk of the shares offered to the public are routed through the book-building route. An illiquid secondary market not only leads to greater volatility but also renders itself vulnerable for manipulation. It may be noted that the Directive Principles of the Constitution of India, ordain “that the ownership and control of material resources of the community are so distributed as best to subserve the common good” and “that the operation of the economic system does not result in concentration of wealth and means of production to the common detriment”.

The Supreme Court has held that “the Fundamental Rights and Directive Principles constitute the conscience of our Constitution”. In fact, the Prime Minister in his Independence Day speech promised that “the functioning of the stock markets and financial institutions will be reformed to protect the interests of small investors”.

A review of the decisions is, therefore, called for and the questions of raising the percentage of public offer for a company to be eligible for listing from 10 per cent/25 per cent to at least 40 per cent of its capital, if need be, in two stages of 20 per cent each, and of restricting the portion of book-building to, say, 50 per cent of the public offer in respect of issues up to, say, Rs 10 crore and 25 per cent of the public offer for issues above Rs 10 crore, subject to a minimum of Rs 5 crore for book-building, need to be considered.

(The writer is Chairman, Inter-Connected Stock Exchange of India Ltd. The views are personal)