SEBI to go the Dutch way on IPOs?

A proposal before SEBI to consider Dutch auction as the method to sell shares of companies in an initial public offering (IPO) has the potential to revolutionise the way public issues are priced. Famously used in the Google IPO, investors have to indicate the price and the number of shares bid for. The results are then tabulated in descending order of prices until the number of shares on offer is covered.

The method will give investors a greater ability to influence the price at which the stock is offered, while taking away the discretion of merchant bankers and the company to do so. At the same time, the method could encourage very aggressive bidding in some public offers, particularly where demand is very strong. Nevertheless, the Dutch auction method can lead to a more efficient price discovery than under the existing price-band based book-building method. Conversely, for retail investors the opportunity to acquire stocks at a discount to the market price would disappear.

Also, the scope to flip the shares immediately on listing, and thus make a killing, would be limited. This would especially be so in the case of companies that have very attractive growth potential, as the demand for the shares of such firms would see the securities priced closer to the market price. That would lower the first-day bounce, the rise in share price immediately upon listing. Consequently, the Dutch auction method may see participation of long-term investors in public offerings.

While the auction method has its merits, frequent changes to the IPO guidelines is not desirable. Also this method is clearly more appropriate for an IPO rather than a follow-on public offer. Nor would we recommend a complete switchover to the new method in the near term. Instead, the regulator should allow companies the option to choose between the auction and the current price-band based book-building. After adequate experience is gained with auction-based IPO and glitches, if any, in the guidelines are identified and addressed, a complete transition may be considered. Meanwhile, the regulator should move to treat qualified institutional bidders on par with other investors on matters such as revision of bids.