Price discovery of delisting offers: Time for a change

By Akila Agrawal, Shardul Amarchand Mangaldas & Co
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Akila Agrawal
Akila Agrawal

One of the key factors that work against exercise of this option is the steep premium one has to pay in a direct delisting offer, where the price is determined by a reverse book building method. Generally speaking, it may be more cost effective to do a fixed-price tender offer, followed by a delisting offer on expiry of the cooling-off period.

The question is whether the reverse book building method that is currently adopted for price discovery of delisting offers has outlived its utility.

Unique situation

India is the only jurisdiction in the world that offers a reverse book building method of price discovery for delisting offers. A majority of the developed markets, such as US, UK, Canada and Japan, do not offer any appraisal rights to minority shareholders. In some other jurisdictions, only dissenting shareholders get appraisal rights and these are normally based on a look-back price or a fair valuation of the stock.

India is unique in offering public shareholders the right to determine the exit price, with the law only prescribing a floor price. The genesis of this methodology dates back to 2002, when a committee chaired by Pratip Kar raised the need for a reverse book building method of price discovery. A fixed-price exit was under scrutiny as a number of multinational companies were delisting shares from the exchanges and historical trading price was not adequate compensation in a depressed market.

The committee was of the view that a book building process would provide a transparent, fair and reasonable mechanism of price discovery. This recommendation was implemented in 2003.

Basic premise

A fundamental assumption that the committee had made in recommending this change was that rational investors would quote a reasonable premium in book building. Market behaviour indicates the contrary. Unlike other jurisdictions where the share price plummets on the announcement of an intention to delist, in India the share price skyrockets due to speculative trading and the shareholders’ right to demand a premium far higher than what could be considered reasonable.

There is no denying that permanent loss of investment opportunity ought to be compensated, but premiums in the range of 50% have historically tipped the balance heavily in favour of the minorities. Moreover, delisting does not result in a 100% squeeze-out of the minority shareholders and there are instances where higher premiums are paid at the final squeeze-out stage.

A few shareholders who do not have any intention to sell have the ability to derail the process, and it is clear that the process is open to manipulation. SEBI recognized this in a concept paper in 2006, in which an alternative price mechanism, namely, 25% premium on the fair value or look-back price of the share, was mooted. Again, in 2014, a fixed-price alternative was considered in SEBI’s concept paper for changes in the delisting regulations. However, neither of these proposals was accepted and the only change has been to reduce the influence of block holders by modifying the exit price to be the highest price at which the promoter touches the threshold limit (as opposed to the price at which the maximum number of shares is tendered).

Conclusion

The reverse book building process as an investor protection method is suitable for new markets. Given the current phase of development of the Indian securities market, it no longer seems to be an efficient method of price discovery. The BSE in Mumbai and the National Stock Exchange are among the world’s leading stock exchanges and it is time SEBI recognizes and supports the principle that delisting is a corporate decision. Companies have the right to delist and cannot be forced to stay listed by onerous regulations.

In most jurisdictions, the decision to delist is simply made by the board of directors and the directors are expected to exercise their fiduciary obligations and act in the best interests of the company and its stakeholders. It is time that SEBI rectifies this anomaly. Investor protection does not necessarily mean protection of minority investments to the exclusion of the interests of controlling stakeholders. It refers to the protection of all investors in the securities market.

Akila Agrawal is a partner at Shardul Amarchand Mangaldas & Co. The views expressed in this article are those of the author and do not reflect the position of the firm.

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