Pricing of initial public offerings

It is observed that investors, especially who invest through the secondary market, are not happy with pricing of initial public offerings (IPOs) being done by the Bangladesh Securities Exchange Commission (BSEC), the regulator, itself. Their concern and complaint are that the IPOs are being priced at the higher side and those lose price in the market after initial few weeks.
The secondary market price, in some cases, goes down below the issued price or par value as the case may be. It is true that the IPO applicants or primary market investors in most cases gain, as most of the IPOs are traded on debut at premium values. But investors think the premium values on debut are nothing but the product of collaborative acts by some big investors who are either individuals or institutions.
One type of gambling surrounds the IPO trading in the first one to two weeks on the debut in the secondary market trading. Once the gamblers switch on to a new IPO trading, the prices of the old IPOs steadily go down and in some cases, end up below the initial sale value or the value charged by the issuing companies for the primary investors.
Now what is the wrong in the pricing of IPOs in the Dhaka stock market? Are they being priced correctly or wrongly at an inflated price, as the investors complain? To know the answer to this question, we should keep in mind that in Bangladesh's stock market, IPOs are not priced by the market; it is priced, or at least consented to, by the regulator itself.
The present method of IPO pricing is that the licensed manager to the issue presents and places the required papers before the BSEC and request for permission for going public with the issue. The manager to the issue, who acts against a fee, normally cites an indicative price and if the BSEC agrees with the manager, the IPO application receives the regulator's nod for going public. But the regulator has the final say with regard to IPO pricing. It can order a price for the IPO lower than the one asked by the issue manager.
The regulator checks out all the submitted papers including the audit reports, and if found in order, goes for permitting an IPO to go public. The regulator can turn down any application for IPO or ask for re-submission with corrections. The regulator can fine or prohibit the issue manager from undertaking such business in future if it finds false and concocted information in the submitted papers.
The licensed manager to the issue is supposed to exercise due diligence while making the papers ready and submitting those to the regulator for permission for going public with the offer. Many a time, the manager to the issue asks for premium price over the par value while wanting to sell IPOs to the public.
But whether to approve an IPO with a premium price or at par value is the sole authority of the regulator, as it is the ultimate permission-giving body in Bangladesh's stock market for public floatation of stocks.
In recent days, a controversy came to the surface is whether IPOs are being properly priced, regardless of whether regulator fixes the IPO price or simply gives consent to what the issue manager asked for. The BSEC, on many occasions, briefed the public that it does not fix the price of IPOs; it only gives consent to it basing on the papers submitted by the issue manager.
The issue manager is supposed to submit no wrong, fabricated, false or misleading information. The auditor also is to bear his part of the responsibility in this respect. By saying this, the regulator wants to say it is not its function to visit the issuing company's offices or factories and also not to verify directly with regard to the issuer's bank loans and tax payment records.
But the regulator, being the sole authority for permitting an IPO for going public, has the responsibility too with regard to the IPO pricing. They say, otherwise, the better option for pricing is to leave the matter to the market or with the investing public with papers and required information made available to them. In that case, IPO will come to the investing public with direct listing as it happens in mature markets.
Unfortunately, in Bangladesh, the direct listing was practised in 2010, but was found to be grossly misused. The direct listing fetched much more capital for the issuer than the capital normally should have been fetched. Why did that happen? Did the investing public make mistakes? Yes, in some cases, they made mistakes but in most cases, they were misinformed and befooled. A hype was created in the demand side of the market and the issuers sold the stocks at unbelievably high prices.
This also happened in stock market scandals of 2010. Then this option of IPO was suspended by the regulator and it has remained so until now. The direct listing is not suitable for Bangladesh's stock market as the market can still be easily manipulated.
The other option for IPO pricing is the one known as the 'Book Building Method'. It is said that this method is a better one for proper price discovery. Professionals can get involved in the process of price discovery. But in Bangladesh, experience with the Book Building System also did not work. The method was misused in the artificially-hyped market of 2010. The better option in this case, we believe, is still the one where the regulator can remain directly involved in IPO price fixing. The only thing the investors want is that the regulator be more prudent in this regard.

The writer is Professor of Economics, the University of Dhaka.
 abuahmedecon@yahoo.com