Book Building and Auctions in Initial Public Offerings


Bookkeeping is a phrase referring to the course of capturing, generating, and recording an investor’s interest in the shares of a given company, during an IPO. It may also be done to other securities, during the IPO issuance course, where the practice is geared at realizing efficient price allocation. Normally, the issuer of the shares or the securities employs the services of an established investment bank, which acts as the underwriter of the securities underwriter for the IPO offer in question. The ‘book,’ is used to refer to the off-market share of the clientele demand by the book runner, and is kept confidential amongst the book runner, underwriter, and issuer.

Generally, equity offerings

These include shares and securities under sale, which are introduced to the market through one of the two methods available for such introductions. The first way is the fixed-price offering, under which the shares or the securities under sale are valued, priced, and then offered for investor subscription. Although the book building approach offers the strength of determining the final offering price based on market demand conditions, it had not received an established usage outside the U.S. before the 1990s. Nevertheless, after its introduction in the late 1990s, the system has been introduced and embraced around the world, making it the default mechanism in the area of conducting IPOs. As of July 1999, an estimated 80% of non-U.S. shares and securities offerings had been introduced into the market using the book building method or its hybrid versions.

The fast-paced take-up of this system may be attributed to a number of factors, including the movement towards global privatization and the increase in the general integration of equity markets around the world. The book-building procedure may have started with the privatization of companies, but later spread into the running of the private sector, due to its effectiveness and the benefits thereof. Even though U.S. investment banks were the early founders of the book building method, they are blamed for having used the experience to outwit U.S. banks operating from abroad.

In evaluating the relative merits of book building and the auctions have done during the offering of IPOs, both the indirect costs surrounding underbracing and the direct costs of conducting IPOs are to be determined. In determining these merits, an account of the following should be drawn: a detailed account of the underwriting fees, syndicate membership, initial returns and the markets in which the shares are traded.

One advantage drawn from the use of book building is the ability to overcome valuation uncertainty, a common scenario when trading shares falling within sectors such as the IT/ Software class. This is the case, as the shares of the companies falling within this class are often very difficult to value. When using book building, this uncertainty is easily detected, thus reliance is built on the revealed shares ‘demand, to determine the value to be allocated to such shares.

The econometric analysis of the book building model is another advantage area, as it gives special regard for the endogeneity of the choices available to the issuer. From the aspects of endogeneity, the valuation process is affected more accurately, a case that offers more security to the issuer, in the area of getting good proceeds from the offer. This is the case, as the pricing is based on feedback from potential investors, thus influencing the investors to buy the largest number of shares. Li (2011) suggests that the book-building process, as opposed to public subscription, leads to different benefits. These benefits include the effect of increasing the underwriting prices towards realizing the intrinsic value of the shares and the reduction of the number of trading days to be taken before the equilibrium prices are reached.

From the article, IPOs and Long-Term Relationships: An Advantage of Book Building, featured in the Review of Financial Studies journal, book building is primarily a U.S. method that has gained increased usage. Book building also offers the opportunity to lower the prices of the offerings, to favor usual and uninformed investment clients. The major advantage of this model is that it can be integrated into other IPO offering methods, so they can complement the weaknesses of each other (Sherman 2000).

According to the article, ‘Book building: How informative is the Order Book?’ featured in the Journal of Finance, the distinguishing factor is that the information from bids reflects the highest and lowest bid prices. This is especially concerning how frequent bidders affect the offering prices of the shares. Also, oversubscription has a profound effect on IPOs, as the public information received affects the price to be allocated, to the extent that it is reflected in the bids. Further, demand elasticity and oversubscription are directly related to the first-day after-sale return, while elasticity is inversely related to this return. From this information, it is conclusive that book building is designed to draw information from potential investors. The evidence in support of the merits of the book-building method can be shown using the following data, in terms of the usage of Boo-building in markets outside the U.S.

From statistical studies, before the 1990s, fixed price methods were the predominant method used in the markets outside the U.S. However, after 1990, the system changed in favor of book building – a change that saw book-building get appraisal across global IPO markets, making it the very established default method of IPO offerings. From the study, statistical evidence further indicated that by July 1999, about 80% of the IPO offerings done outside the U.S. were introduced into the respective markets using the book building method. In other cases, the book-building method was integrated with other methods of IPO offerings, to come up with hybrid IPO offering methods, which were more favorable for the respective markets (Sherman 2000).

The theoretical framework of book building, which is generally an account of what is to be expected in using this method, in submitting IPO offerings, may be summarized by a theoretical formulation based on the indicators explained below. At a time when the investor has indicated a probable price P for an offering firm valued at V, the preventive conditions being dictated by the institutional shareholders and the retail shareholders is marginal to the investigation. Further, the quantity demanded by the institutional shareholder is not questioned; rather, interest is placed upon the share distribution, which the book runner assigns to the depositor, A. Then the computation of the institutional depositor’s profit is calculated as follows.

  • A (V-P)

The core of the pricing difficulty in book building is the challenge of not being able to convince institutional depositors to disclose their real demand levels within their signals of interest (Cornelli & Goldreich 2003). For any institutional investor, the expectation of incentive can be calculated as follows.

  • A (V-Phigh) < A (V-Plow)

In general, the relationship of interest can be expressed at low-interest rates, where firms delay the IPO offers, mainly because during this period, they forego the revenue earnings that do not matter anymore at low-interest rates.

The theoretical framework of a study is basically, the well-thought-out ideals and the questions to be answered after the study. In the case of book building, the framework is that – not only the bidders’ characteristics influence the bidding process and the success of an IPO offering, but also the characteristics of the issuer. This is the core reason, why, the underwriter is consulted, and his underwriting services demanded, mainly because his credibility is reputable. This is because there is a positive connection between IPO biding success and the risk levels associated with the IPO offer in question. In this regard, corporate bonds, which are considered to exert low or medium-level risk, are most likely to realize full success. Also, corporate bids with huge over demand signify hard work on the part of the bidders, in the pursuit to get the full allocation of their bids (Sherman & Titman 2002).

The authors’ hypotheses explained through the article include the following:

The effectiveness of book-building would lead to variations in under-pricing

The expectation from the study was that the effectiveness of book-building would lead to a reduction in under-pricing. However, it should be noted that the empirical findings showed great variations from the findings of other studies, mainly because of the following: the IPOs listed after the establishment of the book-building system will often constitute blue-chip stocks in key industries. As a result of the reputable quality, they are well-received by public investors. Also, due to the promising nature of Book-building after it has been fully established, the result is a rush for the socks, which brings about an increase in the price of the IPOs under the offering. The incidence of bull-market effects leads to variations in the underlying levels (Sherman & Titman 2002).

The effective use of book-building gives signals high-quality firms

This is to explain that the Book-building method gives indications into which firms are of comparably high quality. However, it has also been argued that the firms that tend to fetch a high under-pricing tend to exhibit a low long-term stock return.

There is a resultant ex-ante uncertainty effect on the issuing firms

This hypothesis may be explained that ex-ante insecurity effects decrease considerably after the Book-building exercise. Further, firms with smaller IPO earnings are considered riskier, thus turn to high under-pricing (Sherman & Titman 2002).

Book-building has a profound effect on information variables

The institutional investors taking part in the book-building exercise will gain more experience and expertise in the area of pricing accuracy and avoiding under-pricing.

The characteristics of the ideal book-building experiment

An ideal book-building experiment should feature the following core aspects and areas of IPO offering focus: introduce an analysis of the markets, possibly paying attention to market variations and introducing the areas of executing, managing and monitoring trades, as these vary from time to time. The experiment should also feature the aspects of designs, tests and comparative consideration of the trading systems to be used or those in operation. The ideal experiment should also introduce forward-looking aspects of trading and not just centre on the basics of IPO trading (Sherman & Titman 2002).

The author’s identification strategy

The author’s identification strategy is characteristic of calling for the prediction of the reader. The author tries to influence the activation of the reader’s prior knowledge in the area of trading and IPO offering, which he then uses to build his arguments and introduce new ideas. Another identification strategy implied through the article is connecting, which requires that a reader comprehends the article by connecting previously held knowledge and the new ideas presented through the text. This is of importance, as it helps the reader grasp the ideas faster and in a better manner. However, the reader should be able to continue to use the strategy as they read through the article, as this will help make continual connections as they read through the article (Sherman & Titman 2002).

The other identification strategy which is evident through the article is inferring, which is a strategy that calls for the reader to grasp the ideas from the article, then blend it with their ideas, to come up with a wholesome information base. During the making of inferences, the author intends that the reader reaches conclusions, establishes predictions and judgments, to create a unique interpretation of the ideas portrayed through the text.

This strategy induces the reader to move from the literal level of understanding to creating ideas of what is not expressly explained through the reading. However, it should be noted that the inferences made by the reader may end up unresolved by the author – in the manner of being rejected or confirmed. Other identification strategies that are introduced in minor ways include the following: visualizing, synthesizing, skimming, self-questioning, determining importance, scanning, rereading, and summarizing (Sherman 2000).

From the article, sample size and sample design issues were fully addressed, though it is possible that the author did not offer a full response to the surveys for the study. This is evident from the author’s addition of a virtual 10% to the sample size, as a way of compensating for the respondents who were not contacted to give their feedback. The sample size for the evaluative study was also increased by 30%; a move intended to compensate for the non-responsive cases. From this problem, it is possible that the inflation of the sample size did not resolve the potential bias expected to result from informant nonresponse (Sherman 2000).

The methodology used by the author and appropriate nature in answering the research question

The survey research methodology was used for the compilation of the statistics contained in the articles. The major reason why surveys were used is that they are effective for studying large populations and giving information on the social issues affecting the desired outcome. The survey method was effective in answering the research questions, as it gave the desired information regarding the usage of Book-building. For example, from a Brazilian survey, it was documented that only 19 of 557 bids showed a difference in the manner of prorate and actual allocation (Sherman 2000).

Comparison of the methodology used

From comparing the methodologies used in the accounts documented in the literature discussed in Part I and that of the article discussed in part II, there is no significant difference. This is the case, as both accounts have drawn their statistics from surveys carried out in different areas. In short, there is no innovativeness introduced in the literature discussed in part II (Sherman 2000).


Cornelli, F & Goldreich, D 2003, ‘Book building: How Informative is the Order Book?’ The Journal of Finance, vol. 57, no. 4, pp. 5-9.

Li, J 2011, ‘Book-Building, Price Limits Removal, and IPO’s Stock Price Behavior in Taiwan: Share Allocation Mechanism Matters’ International Research Journal of Finance and Economics, vol. 81, pp. 141-143.

Sherman, A & Titman, S 2002, ‘Building the IPO order book: under-pricing and participation limits with costly information,” Journal of Financial Economics, vol. 65, no. 1, pp. 3-29.

Sherman, A 2000, Review of Financial Studies, fall 2000 Issue. Web.

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