Dear Sebi, don’t dilute existing norms for delisting

Sebi’s proposals to revise extant norms for taking a company listed on the stock exchange private — that is, to delist the company — stand to harm the small investor. Not just the foolhardy ones that invest directly in the market but also those who invest through mutual funds and insurance companies.

Perhaps this is why the august group that Sebi appointed to propose revised norms contains, for the most part, representatives of institutions that make money from delisting, and not a single one from a mutual fund, the insurance industry or asset managers under the National Pension System (NPS).

Why would anyone voluntarily want to take a company private? Being listed brings with it certain privileges and associated obligations. The biggest privilege is potential interest from the giant pools of capital that scout the listed universe for investment opportunities — FPIs, mutual funds, pension funds as well as the insurance industry that must deploy the funds collected as insurance premium to generate maximum returns, subject, of course, to prudential norms of allocation to minimal risk government securities. High share prices translate into high net worth for promoters, and the opportunity to raise more capital by pledging shares.

The theory is that the market would allocate capital efficiently to those companies that would generate optimal returns. Charismatic founders can fool a bunch of VCs to bloat their valuations. But when their companies list, the collective wisdom of the market would wipe out the valuation for hype and bring down the share price to reflect reality.

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In the case of WeWork, the real estate company offering shared workspaces that passed itself off as a hi-tech star, for instance, the theory worked well. The theory markedly failed in the case of the infamous meme stocks championed by groupies on Reddit.

But listing also obliges the management to be more transparent, compliant with governance norms, and accountable to public shareholders, analysts and representatives of investment pools. Quarterly earning expectations are described as a downer, forcing companies to focus on the short term, instead of on the long term. However, public markets have supported companies like Amazon and Tesla for years, disregarding miserable quarterly results and looking only at the long term.

A promoter can seek to delist a company to revamp its operations insulated from constant probing of their actions and motivations. They may wish to take advantage of a forthcoming, favourable shift in their company’s fortunes that is not in the public domain, and capture all the potential stock price gain, by buying up every floating share on the market. It might be a regulatory change in the offing, a new technology or an acquirer willing to offer a fancy control premium. Or something else.

Shares do not merely bestow a right to the profits the company makes, but also vest a degree of control over the company. If a majority of shares are held by one entity, that entity can wield control. Typically, when one company takes over another company, the price offered per share of the acquisition target is way above the market price because it would factor in a premium for taking over control of the company.

When a company is taken private, the acquirer is gunning for absolute control, without being answerable to any other shareholder. The delisting price must incorporate an ‘absolute-control premium’, and it must accrue to all existing
shareholders.

Even the reverse book-building process in current delisting norms fails to capture the absolute-control premium adequately. In reverse book-building, the would-be acquirer offers to buy up shares of the company at a price at least equal to the best price paid by the acquirer in the past six months, or an average of a range of past prices.

Shareholders would, over a five-day period, offer to sell as many shares as they like at the offered price or a higher price.

The price that would make available to the would-be acquirer at least 90% of outstanding shares of the company is the potential price at which delisting can take place — if the would-be acquirer is willing to accept this price. If the price is found to be too high, a counter-offer can be made. If that fetches 90% of the shares, delisting can proceed.

Even this reverse book-building does not guarantee a control premium, as these are linked to backward-looking prices, while the only motivation for acquiring more shares is that the company’s prospects stand to improve significantly, pushing up stock prices. The current proposals seek to dilute the already weak book-building norms. This represents plutocracy on the stock market, while broad-based capitalism calls for democracy on the stock market and the market for corporate control, as well.

Sebi must withdraw its current proposals and appoint a fresh committee, comprising representatives of small investors as well as of would-be acquirers, to find a mechanism that is fair to delisters, A-listers, the small investors and, via broad-based growth, the vast majority of no-listers.