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Initial Public Offerings: Going By The Book

Author

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  • Lawrence M. Benveniste
  • William J. Wilhelm

Abstract

In the U.S., and increasingly in other countries as well, IPO securities are marketed to investors in a process known as “book‐building”—one that amounts to polling institutional investors to establish a demand schedule for the issue and then allotting stock to individual investors according to the strength of their professed interest. Although book‐building methods require use of discriminatory tactics that have attracted strong criticism from investors and regulators, this article defends such practices by demonstrating that book‐building is more efficient than alternative methods. It effectively allows issuers to increase the net proceeds of their offerings by making better use of information about market demand conditions. In the process of explaining the efficiency of the book‐building method, this article also offers a plausible explanation for a phenomenon that has long puzzled economists: the systematic underpricing of IPOs. The key to the success of a book‐building effort lies in the use of a strategic pricing and allocation policy designed to offset the investor's incentive to understate his or her interest in an IPO. By committing to favor investors who provide strong indications of interest with relatively large allocations of underpriced shares, the investment bank can limit the distortion of investor's incentives in bidding and so increase the level of proceeds the issuing firm can expect to generate from its IPO.

Suggested Citation

  • Lawrence M. Benveniste & William J. Wilhelm, 1997. "Initial Public Offerings: Going By The Book," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(1), pages 98-108, March.
  • Handle: RePEc:bla:jacrfn:v:10:y:1997:i:1:p:98-108
    DOI: 10.1111/j.1745-6622.1997.tb00130.x
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    Citations

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    Cited by:

    1. van Bommel, Jos & Vermaelen, Theo, 2003. "Post-IPO capital expenditures and market feedback," Journal of Banking & Finance, Elsevier, vol. 27(2), pages 275-305, February.
    2. Cornelli, Francesca & Goldreich, David, 1999. "Bookbuilding and Strategic Allocation," CEPR Discussion Papers 2160, C.E.P.R. Discussion Papers.
    3. Evans, Lewis, 1998. "The Theory and Practice of Privatisation," Working Paper Series 19035, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    4. Biais, Bruno & Faugeron-Crouzet, Anne Marie, 2002. "IPO Auctions: English, Dutch, ... French, and Internet," Journal of Financial Intermediation, Elsevier, vol. 11(1), pages 9-36, January.
    5. Guo, Haifeng & Brooks, Robert, 2008. "Underpricing of Chinese A-share IPOs and short-run underperformance under the approval system from 2001 to 2005," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 984-997, December.
    6. Benveniste, Lawrence M. & Busaba, Walid Y. & Wilhelm, William Jr., 2002. "Information Externalities and the Role of Underwriters in Primary Equity Markets," Journal of Financial Intermediation, Elsevier, vol. 11(1), pages 61-86, January.
    7. Benveniste, Lawrence M. & M. Erdal, Sina & Wilhelm Jr., William J., 1998. "Who benefits from secondary market price stabilization of IOPs?," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 741-767, August.
    8. Guo, Haifeng & Brooks, Robert, 2009. "Duration of IPOs between offering and listing: Cox proportional hazard models--Evidence for Chinese A-share IPOs," International Review of Financial Analysis, Elsevier, vol. 18(5), pages 239-249, December.
    9. Boehmer, Ekkehart & Fishe, Raymond P. H., 2004. "Underwriter short covering in the IPO aftermarket: a clinical study," Journal of Corporate Finance, Elsevier, vol. 10(4), pages 575-594, September.
    10. Chitru S. Fernando & Srinivasan Krishnamurthy & Paul A. Spindt, 2002. "Is the Offer Price in IPOs Informative? Underpricing, Ownership Structure, and Performance," Center for Financial Institutions Working Papers 01-33, Wharton School Center for Financial Institutions, University of Pennsylvania.
    11. repec:vuw:vuwscr:19035 is not listed on IDEAS
    12. Evans, Lewis, 1998. "The Theory and Practice of Privatisation," Working Paper Series 3936, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    13. Fernando, Chitru S. & Krishnamurthy, Srinivasan & Spindt, Paul A., 2004. "Are share price levels informative? Evidence from the ownership, pricing, turnover and performance of IPO firms," Journal of Financial Markets, Elsevier, vol. 7(4), pages 377-403, October.
    14. Cristián Celis & Gustavo Maturana, 1998. "Initial Public Offerings In Chile," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 1(1), pages 7-31.
    15. Sheela Devi Sundarasen & Afzal Khan & Nakiran Rajangam, 2018. "Signalling Roles of Prestigious Auditors and Underwriters in an Emerging IPO Market," Global Business Review, International Management Institute, vol. 19(1), pages 69-84, February.

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