Mandates Don't Fit Market

Mandates Don't Fit Market

Smith Op-Ed in The USA Today
October 17, 2002

Everybody complains about "initial public offerings" (IPOs). Start-up firms think preferred investors are bleeding off capital they need for expansion. Investment bankers worry that their rainmaker reputations are drying up. Small investors worry that everyone else got a better deal. And, of course, in our litigious society, everybody rushes to court whining, "They didn't tell me I could lose money!" Calls for new laws that would "ensure" a better IPO process are growing.

One such idea, called "Dutch auctions," may well have merit. Such auctions remove much of the discretionary power from the brokers. Everyone bids the price they would pay for a number of shares, the broker accepts offers until the market clears, and that market-clearing price is then charged all investors. Proponents argue such auctions are more efficient and equitable, provide fairer access to smaller investors and eliminate the preferential treatment of the good-old-boy network that characterizes the clubby investment banking system. And they may - in some cases - be right.

But before rushing from the frying pan, one should reflect on the vast differences among firms seeking equity. Some firms have well-developed business plans; others are speculative, offering only hopes. Uniform pricing has its virtues, but differential pricing is critical to the survival of many industries. That may be true of investment banking also. Brokers must attract investors, and differential pricing, by allowing more effective sharing of risks, may be needed.

Of course, if regulations now limit auctions, they should be repealed. But we should not mandate this or any other innovative IPO concept. The goal should be to ensure competition in the critical capital-acquisition process, not to impose a one-size-fits-all straitjacket. For too long, political planners have presumed that an expansion of the nanny regulator state would make everything better. It wasn't true for airlines. It surely isn't true for something as complex as capital markets.

Dutch auctions may be a superior answer in many IPO cases, but there may be many other cases in which some other model may work better and even many cases in which the current approach may well be superior. That decision should be made by the markets, not by politicians.