Book-Building System: Will it Really Help to Build the Market?
Journal of Business Research, Vol. 8, June 2006
15 Pages Posted: 15 Dec 2006
There are three widely practiced approaches in pricing the initial public offerings (IPOs), such as public offer, tender or auction and book-building. The key difference between book-building and other IPO methods is that the book-building method gives underwriters control over the allocation of shares whereas others do not. Apart from the differences, all the mechanisms have one thing in common that is, pricing-relevant information is obtained directly from potential buyers in the primary market. Book-building, primarily used in North America in the 1980s, got momentum by the end of the 1990s, touched Europe, Asia and Latin America. However, public offer method is becoming less common worldwide except in smaller countries that rely mainly on retail investors. Auctions are rare these days. Book-building dominates the IPO pricing mechanisms because it results in higher net proceeds, enables smaller and riskier firms to access public equity markets, enables issuers to raise larger amounts of capital, provides liquidity for early investors, places shares with preferred types of investors, and encourages underwriters to provide important aftermarket services, although book-building is widely believed to be an expensive process compared to other alternatives. However, only cost differences between book-building and other approaches are not sufficient to outweigh the benefits investors perceive. Recently the Securities and Exchange Commission (SEC) of Bangladesh is planning to introduce book-building system replacing the year old fixed price method. The SEC thinks that this will encourage good-performing local and foreign companies to float IPOs as they are ensured to have fair price for their shares. The critics, on the other hand, think that book-building will permanently throw out general investors from the capital market making the market fully elite class. From the public policy point of view, SEC should not introduce such a system. In such a situation, SEC may continue with both the existing lottery method and the book-building in parallel as it is in the US, where book-building is used for larger IPOs and auction/public offer method for smaller issues or there can be a hybrid system of book-building and other IPO pricing mechanisms.
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