Don't relax MPS requirements: Easing rules won't aid corporate governance

The Indian capital market's growth has been truly impressive in recent times. Since 2019, the market cap-to-GDP ratio has increased from 81% to 135%

The objective and rationale of the recent Securities and Exchange Board of India (Sebi) decision to relax the minimum public shareholding (MPS) requirement at the time of listing and provide longer timelines for meeting the regulatory threshold for large issuers need to be examined from the point of view of public investors and corporate governance.

 

The regulator’s stated objective is to facilitate initial public offerings (IPOs) by large companies. The rationale given includes that substantial dilution would be difficult for the market to absorb; companies may not need more funds; immediate dilution can lead to oversupply of shares in the market; and anticipation of further dilution may impact share prices.

 

The regulator has divided companies into different categories for giving this relaxation. For large companies, it goes to the extent of allowing a minimum public offer of only 2.5 per cent at the time of listing, and a long time period of 10 years to reach the MPS threshold of 25 per cent.

 

Now, which companies are likely to fall in this category? Apart from some government-owned companies, these would be those held by promoters with deep pockets, who are able to raise substantial funds from private equity investors and strategic partners through private placements. A public listing, besides giving better visibility to the company, provides an exit opportunity to such investors, which in turn would facilitate more pre-IPO private investments. Certainly, it is not with the purpose to raise fresh funds. A 2.5 per cent public offer, even if the whole of it were to be fresh issuance, would be a mere drop in the ocean for such a company.

 

How about the new investors buying equities through the IPO route? It could be argued that public investors joining the bandwagon via the public offering get an opportunity to share the pie and, therefore, benefit from the listing. This presumption needs a closer examination. Does the regulatory relaxation relating to MPS treat these stakeholders fairly, or is it even likely to result in any consequential improvement in the corporate governance of the entity?

 

Few would dispute that ideally, companies going for an IPO should be mandated to achieve the 25 per cent MPS requirement in one go, right at the time of listing. Imagine the difference in discovered price under two scenarios — a  25 per cent dilution at the time of listing versus a mere 2.5 per cent dilution with a 10-year horizon to reach 25 per cent. 

 

The Indian capital market’s growth has been truly impressive in recent times. Since 2019, the market cap-to-gross domestic product (GDP) ratio has increased from 81 per cent to 135 per cent. The number of demat accounts has risen from 36 million in April 2019 to over 207 million now. Reportedly, Indian markets have seen the fourth-largest fundraise globally via IPOs in 2025 so far. While surely there is much scope to further deepen the market, is inadequate market depth a sufficient ground to allow this relaxation? Probably not.

 

The valuation of an unlisted company is a tedious and complex task, with the perception of institutional investors and merchant bankers playing a dominant role. Notwithstanding the unprecedented boom in the IPO market in recent years, a significant difference between the issue price and the listing price, especially in large issues, has often soured investor sentiment. The proposed timelines for further dilution to reach the ultimate MPS requirement would add to the dilemma and confusion of investors.

 

As for corporate governance, a public shareholding of just 2.5 per cent would be of little relevance. Passing resolutions at annual general meetings would be a joke. Even for corporate actions for which Sebi prescribes approval by the majority of minority shareholders, the overwhelming majority shareholding would have a psychological impact on the behaviour of the minority shareholders, refraining them from taking rational decisions.

 

Sebi should reconsider this policy decision. A 25 per cent MPS should be prescribed right at the time of listing. At best, it could perhaps be relaxed to 10 per cent at the time of listing, with two to three years to reach 25 per cent. At least on paper, shareholders holding 10 per cent collectively would have specific rights, including requisitioning an extraordinary general meeting and filing a petition with the National Company Law Tribunal (NCLT) if they are subject to oppression or mismanagement. No further relaxation in timelines should be allowed under any circumstance. If required, the large issuers may consider restructuring their business structures and models. For instance, they may consider hiving off activities into different subsidiaries, and then consider listing them. As for the inadequate market appetite argument, Sebi may conduct a credible study and, if needed, with a view to discourage bunching of issuances, think in terms of phasing them out over a period based on rational principles.

 

Staying with the discussion on passing resolutions by shareholders, the Companies Act, 2013, requires the assent of 50 per cent or more of shareholders, in value terms, to pass an ordinary resolution. For special resolutions, the threshold is 75 per cent. Thus, even the existing prescription of 25 per cent MPS may not be sufficient to contain any egregious behaviour on the part of promoter shareholders.

 

The 2019 Budget had suggested increasing the MPS to 35 per cent. However, free-market enthusiasts argued that a higher public shareholding will likely happen on its own as the market matures, and therefore there is no need for such a prescription. Unfortunately, as it happens with many such desirable objectives, relying on voluntary action seldom works in our country. Thus, there may be a need to revisit this proposal. The MPS requirement may be raised to at least 30 per cent. Alternatively, the threshold for passing special resolutions could be increased to 80 per cent under the Companies Act.

 

Another important aspect is that a higher public shareholding does not necessarily imply a higher number of shares available for secondary-market trading. Shares held by associate or group companies, entities having a nominee director on the company’s board, directors of the company, central/state government, corporations having strategic interest, and other long-term investors (including some foreign direct investors), though falling within the definition of public shareholders, are not likely to be ordinarily available for trading.

 

The concept of MPS needs to be replaced by that of “free float” to have a fair assessment of the percentage of shares of a listed company that are likely to be freely available for trading. Though the stock exchanges and index providers use free float criteria, their definition of free float varies. The market regulator should build a consensus among stakeholders on the definition of “free float” to replace the MPS requirement.

 

Many would scoff at above suggestions and argue that they go against the “ease of doing business”. But remember — protecting the interests of investors is the primary function of the regulator, as also stated in the preamble of the Sebi Act.

 

The author is a distinguished fellow at the Observer Research Foundation, former Sebi chairman, and a former IAS officer