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Christoph Schumacher, Sasha Molchanov: Govt more interested in selling up than price efficiency

Bill English (left) with Doug Heffernan of Mighty River Power before its partial float. Photo / Greg Bowker
Bill English (left) with Doug Heffernan of Mighty River Power before its partial float. Photo / Greg Bowker

When the Genesis Energy share offer opens on March 29 it will be the fourth and final float in the Government's partial asset sales programme. And it will be very different to the previous share offers.

While the Government considers its floats so far to be successful, it is taking a different approach with the Genesis share offer by announcing the share price the night before the offer goes public. An indicative price range of between $1.35 and $1.65 has already been set, which is well below the range expected by experts in the field.

The upfront announcement is widely viewed as a move to encourage more people to buy shares. Knowing the share price before you buy is definitely attractive for investors, but there are other economic factors to consider.

The Mighty River Power and Meridian share offers were executed in what is called the "United States way".

The price is not announced until just before trading commences, which is designed to obtain the highest price for the issuer while avoiding large post-offer price declines.

In the time between the offer announcement and price setting, the issuer conducts a book-building process aimed at gauging demand for the offering.

The clear downside to this approach is that investors do not know the price of the shares they have applied for, and this can be a turn-off for them.

However, the United States-style share offer mechanism has a big advantage - market forces have a direct impact on price setting, thus making it more efficient. Can the market still get it wrong? Sure - both Mighty River and Meridian demonstrated this by suffering price declines. But in terms of pricing efficiency, we have no better mechanism than the forces of supply and demand.

The alternative share pricing mechanism is the so-called "British system", which is what the Government is using for the Genesis share offer.

With this method, the announcement of the offer and share price are made at about the same time. Clearly, investors are in an advantageous position because they know exactly what price they will pay.

But the British system has a serious drawback because the share price is essentially a guess. Market mechanisms have little, if any, impact on the price. The first time the market can reveal its opinion is on the day trading commences. This can bring large price movements.

If the price is set too low, money is left on the table and assets can be sold off at a discount. This is neither desirable nor efficient, and could open the Government to the criticism of selling assets cheaply to rich investors. Set the price too high, however, and mum and dad investors suffer losses.

The Government is trying to pre-empt this fear with a scheme that gives investors a bonus share for every 15 shares if they keep their shares for more than 12 months.

The British-style share offer system is widely considered less efficient than its US-style counterpart, and is not commonly used. So why has the Government chosen to take this approach?

The answer comes from the nature of the share offer process. A "normal" share offer is pretty much unavailable to mum and dad investors because institutional investors usually snap up all the shares. The only time small investors get a look-in is when not enough institutions have subscribed - a clear indication that the offer is weak and likely to suffer post-trading losses. This is called "winner's curse".

In the case of the Government's partial asset sales programme, New Zealand residents are guaranteed a certain share allocation. This is pretty much the only time that mum and dad investors can get into the share offer game.

In reality, Finance Minister Bill English is between a rock and a hard place. With previous floats, the share price wasn't announced in advance and potential investors were put off by price uncertainty.

But now that the price is being set upfront, Mr English might put too much money into investors' pockets, rather than the Government's coffers. So only one thing is certain: with the Genesis Energy share offer the Government is more interested in selling all its shares than price efficiency.

Professor Christoph Schumacher and Associate Professor Sasha Molchanov are researchers at Massey University's School of Economics and Finance.

- NZ Herald

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