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Topic: General Discussion
The ascending price model, which the English auction is all about, admittedly results in the best price discovery. But when several commodities, which are on all fours with each other like shares of a company, are to be auctioned, the English model comes a cropper because it is neither possible nor desirable to sell all the shares on offer to a single person.
In other words, when homogenous commodities have to be sold simultaneously to more than one person, the English model has to make way to other models that are amenable to identifying multiple takers for what is on offer. The Dutch and French models stand out as appropriate to the situation with vastly different incidents and implications both for the auctioneer and the participants in an auction.
Tulips and perishables
Tulips are a rage in the Netherlands, and have been one of the mainstays on the export front. Being a perishable commodity, however, fast disposal is the key to its disposal at an optimum price which need not be the best in the circumstances. The Dutch auction system then arose to address the peculiar problem posed by perishables and is the diametric opposite of the English model — it is a descending price model.
It was necessary to ensure that the product did not rot for want of takers. In other words, if the English model follows the bottom-up approach, the Dutch follows the top-down approach with the auctioneer progressively climbing down his high horse so as to ensure that at least someone is around evincing interest in the product on offer.
Soon this model came to be adopted with a slight variation for homogenous products such as shares on offer — the lowest bid at which the last share on offer by a company is taken up, becomes the benchmark for allotment of shares to everyone in the race, including to the one who bid the highest price albeit for a fraction of the shares on offer in which alone he is interested.
To wit, if 100 lakh shares of a company are on offer and there are four bidders with the first one evincing interest in 50 lakh shares at Rs 400 each, the second one 30 lakh shares at Rs 300 each, the third 20 lakh shares at Rs 200 each and the fourth 50 lakh shares at Rs 150 each, the bid would be closed at Rs 200 per share, the price at which all the shares on offer have been taken and this would be the price at which the two higher bidders too would get the shares with the fourth one losing out in the race. This has been the price discovery model under the extant book-building process till recently, till the Government woke up to the potential of the French model.
The French model is rigid and expects the bidder to stew in his own juice. In the above example, the first bidder would have got the 50 lakh shares he coveted at Rs 400 each, the second one the 30 lakh shares at Rs 300 each and the third 20 lakh shares at Rs 200 each. The French model brooks no revision of bids nor does it allow the highest bidder to ride piggyback behind the lowest bidder who stepped on the scene to ensure successful hawking of the last share on the block.
The Government, which has been gradually disinvesting in the public sector companies, has been enamoured of the French model with its potential for garnering more by way of disinvestment proceeds vis-à-vis the Dutch model that has been holding sway for around two decades now after the dismantling of the dirigisme orchestrated by the office of the Controller of Capital issues.
That it chose the French model at an inopportune time for an inappropriate purpose does not detract from the intrinsic merit of the model. The French model is not appropriate for a Follow on Public offer (FPO) where the market quotation comes to guide the bidders and applies the brake when they show excessive zeal especially when sentiments are down.
SEBI's take
The market regulator SEBI has done well to call upon the participants in the book-building process to cough up 100 per cent of what they bid as against the extant norm of just 10 per cent which is considered a downright discrimination against the public who are expected to pay up fully along with their applications.
But while doing so, it has taken care to clarify that there is no compulsion to adopt the French model implying thereby the choice rests with individual companies as to whether they want to follow the Dutch or the French model. It would be in the interest of the company as well as in the very interest of the credibility of the auctioning system that the French model is adopted because not only would the issuing company be able to garner more funds but more importantly the farce of prescribing a narrow price band would come to an end.
Under the French model, while a floor can be set, no ceiling can be prescribed. It is downright farcical to ask bidders to bid within a narrow band of, say, Rs 400-450 per share of Rs 10 because the upshot is the price has already been discovered substantially by the company itself.
The French model constitutes a true price discovery process without cramping the enthusiasm of the bidders especially in a buoyant market. Shares are not tulips. They are not perishables so as to warrant a climb-down from the high horse on the part of the auctioneer.
Having called upon the bidders to cough up the full amount bid, SEBI should also tie one to his bid without allowing him the luxury of taking a French leave, as it were, which happens when the group of bidders assign the insidious task of lowering the cost for all of them by anointing one amongst them to quote almost at the floor price.
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