'Rational man' regulation: A farce

In mid-July last year, CarTrade, a website to buy and sell used cars and car financing, was listed. The initial public offering (IPO) was priced at Rs 1,585. Last week its stock price closed the week at Rs 640, a loss of 60 per cent in seven months. A couple of months later came Policybazaar, with its IPO priced at Rs 980. Last week, the stock closed at Rs 524, a fall of 47 per cent. A week after Policybazaar came Paytm, the ubiquitous payment platform, which made an issue at Rs 2,150. It was the biggest ever IPO. Last week, Paytm’s price was Rs 709, a fall of 68 per cent. Most other IPOs of the last one year have met with a similar fate, and this includes the big daddy of them all —Life Insurance Corporation of India. Many people took to social media to complain bitterly about the rapacious pricing of IPOs and blaming the market regulator for allowing greedy issuers and investment bankers to gyp the innocent public.

This phenomenon — IPOs quoting well below the issue price — is not new. They are often a bad deal for retail investors. This is because investors have no control over when to buy and at what price to buy —two crucial factors that determine returns. In an IPO these two factors are dictated by the promoters and investment bankers. They fix the time and price to benefit themselves. But then investors ought to have done their homework before making a decision to buy. They didn’t. They allowed themselves to be influenced by intermediaries, brand, hype, greed, etc. Amazingly, it is the same story every time and at every place. This is what John Rothchild, a financial writer, famously said about investors in his book: A Fool and His Money: The Odyssey of an Average Investor. “People who spend a week choosing a furniture refinisher will sign up with the first [financial planner] who calls. People who circle junkyards for matching hubcaps will buy mutual funds without reading the prospectus. People who check the expiration date on cottage cheese would not think of investigating the background of their broker …”

But here is a thought. If most investors invariably act like this, at every time and place, it means that we are all fundamentally flawed as humans when it comes to making financial decisions. We just cannot help it. We seem to be hardwired in a way that forces us to make such mistakes. Indeed, behavioural finance does establish this to be true with umpteen experiments that have been conducted over the past four decades. Faced with multiple choices, when we are supposed to think carefully, we act impulsively. The antidote to such mistakes is to train our minds to deal with biases and also historical knowledge. But financial literacy is not part of the academic curriculum in India, nor are we made aware of our inherent behavioural biases. Indeed, no one even tells investors the most important truth about investing — that it is a battlefield out there and they are on their own; no one is their friend. Hence, it is obvious that making financial mistakes would be the norm, and a diligent, well-read and thoughtful investor would be the very rare exception.

Yet, all regulations are framed with the “rational man” in mind, just as economists adopted the concept of “the economic man” to explain that faced with economic choices we would seemingly maximise our gains at any cost, which is often untrue. The concept of rational man has yielded the concept of disclosure-based regulations. The ridiculous regulatory assumption is that investors (rational men) are supposed to read 500 pages of legalese in an IPO prospectus, think hard, do a lot of research, probably create financial models and then decide whether or not to invest. If they have not done all of that, well, they cannot complain. Disclosure-based regulations for the rational man are a charade but it would be hard to dislodge since it is now both a regulatory orthodoxy and serves the interests of investment bankers and issuers.

In fact, not only are we likely to continue with the nonsense of disclosure-based regulations, we are likely to get a lot more of it. Last week, the news agency PTI quoted an anonymous senior official of the Securities & Exchange Board of India (Sebi) saying that the regulator would harness the “huge capabilities” it had created over the decades, including cutting-edge technology and data to “analyse things that have gone good or bad for the investors” and pass it on in the form of “risk-factor disclosures”. It aims to help investors “avoid the herd mentality that has been particularly visible in recent years” beginning with the pandemic and also the “recent losses sustained by investors” in IPOs and derivatives transactions. In a global first, it would assist investors through monthly “risk factor disclosures” on market trends, including surges and crashes. Well, I can guarantee nobody would read such disclosures, or make decisions based on them, just as they don’t read IPO prospectuses. It is quite amazing that decades after behavioural finance has shown us the truth about real-life human behaviour, regulators cannot stir themselves to drop the rational man assumption and incorporate even a smidgeon of that learning. The current disclosure-based system created by regulators does nothing to help the investors. But it is investors, not the regulators, who pay the price.

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The writer is the editor of www.moneylife.in 

Twitter: @Moneylifers