International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 38 (2010)

© EuroJournals Publishing, Inc. 2010
http://www.eurojournals.com/finance.htm

Is Bookbuilding an Efficient IPO Pricing Mechanism?-The

Indian Evidence

S S S Kumar1
Associate Professor, Finance, Accounting & Control Area
Indian Institute of Management Kozhikode IIMK Campus P O Calicut 673570 India
E-mail: ssskumar@iimk.ac.in
Tel: +91-495-2809245; Fax: +91-495-2803010

Abstract

This paper examines the efficiency of IPO issuing mechanisms using a sample of
Indian IPOs that tapped the primary market during 2003-07 by taking in to consideration
the total costs the issuers have to face i.e., including both direct as well as indirect costs.
We find that from a total cost point of view the issuers fare neither better nor worse using
either bookbuilding or the fixed price offers. Our results also showed that the issue
expenses associated with bookbuilding are more than those associated with fixed price
offers after controlling for issue size and firm specific characteristics. Further analysis
showed that employing US based lead managers do not translate in to higher issue
proceeds. Finally, the costs of the services of US lead managers are not significantly
different from those of Indian lead managers.

Keywords: IPO, bookbuilding, underpricing

1. Introduction
An Initial Public Offering (IPO) is a company’s first offering of equity to the public and IPOs are a
major source of capital for firms. There are atleast three distinct mechanisms available for an issuing
firm – fixed price offer, bookbuilding, and auctions. In some countries only one of these methods is
available whereas in some other countries firms may have a choice.
In a fixed price offer the price will be set by the issuer in consultation with the merchant banker
prior to the offer and allocation. In case of excess demand shares will be allotted on a prorate basis
and/or on a lottery of draws. In a typical auction investors are invited to submit bids indicating both the
number of shares and the price they are willing to pay. From the bids the market clearing price will be
determined. Then the shares will be issued to all the successful bidders at a uniform price (popularly
known as Dutch auction) set at the level of the bid of the lowest successful bidder. Bookbuilding
entails soliciting investors to submit the number of shares they would like to buy and at a price that has
to be in a specified price range. Once the books are closed the issue price will be set by the merchant
banker. An important distinction between bookbuilding (free from regulatory restrictions) and auctions
is the merchant banker has complete discretion in the allocation of shares once the price is arrived at

1
I put on record my sincere appreciation to Victoria Management School, Victoria University Wellington, for hosting me
in the summer of 2008 during which I completed substantial part of this work. An earlier version of the article was
presented at the 21st Australasian Banking and Finance Conference held at Sydney during December 2008.
International Research Journal of Finance and Economics - Issue 38 (2010) 174

whereas in auctions the pricing and allocation rules are to be announced well in advance of the bidding
stage.
Recent empirical studies report that there is a world-wide growing popularity of the
bookbuilding method of conducting the IPOs. Sherman (2000) shows that bookbuilding had become
the preferred method of pricing IPOs in over forty countries while the studies of Ljungqvist et al.,
(2003) and Sherman (2005) claim that in almost all the markets where bookbuilding has been
introduced, pre-existing methods have almost faded into oblivion. In consonance with the global
trends, in India too bookbuilding has become the pre-eminent method of pricing IPOs in the recent
past. In this study we set out to investigate whether bookbuilding method of IPO pricing had been
successful in efficient pricing of IPOs.

2. IPO Pricing Mechanisms in India

Indian capital markets witnessed atleast three broad regimes of different hues of IPO pricing
mechanisms over the past two decades starting from a regulated pricing regime to the current
bookbuilding process. Till the early nineties like many other markets in India, capital markets in
general and IPO pricing in particular, was a thoroughly regulated activity with the Office of the
Controller of Capital Issues (CCI) determining the price (based on some archaic formulae) at which a
company can sell its shares to the investors. As reforms set in, CCI was abolished paving way for SEBI
(Securities and Exchange Board of India, counterpart of SEC in the US), IPO pricing had also
undergone a change with the fixed price offer method coming in to being wherein the issuer has
complete freedom over pricing and selling the shares as long as they can garner the stipulated
minimum subscription levels. Though the issuers were having full freedom to price their issues IPO
literature documented short-run under pricing levels that were higher than those witnessed in other
countries (see Madhusoodhanan and Thiripalraju, 1997). Bookbuilding (known in the US as firm
commitment contract) method of pricing IPOs came in to being in the mid-nineties as a result of the
recommendations of the Malegam Committee which was set up by SEBI in 1995 with the basis of
pricing the issue as one of the terms of reference. Initially bookbuilding didn’t took-off in a big way
but with some amendments and revisions it gained popularity.
At a broader level bookbuilding in India is similar to that followed in other markets like the
U.S. The issuing company enters in to an agreement with a merchant banker, known as Book Running
Lead Manager, (BRLM) (the counterpart of Underwriter in the US) who will direct the entire process
as per SEBI guidelines. An important step in the pricing process commences with the BRLM preparing
the Red Herring Prospectus that contains inter alia an indicative price range arrived at based on the
valuation efforts of the BRLM and the minimum acceptable price for the issuer. Now the BRLM will
solicit bids from interested investors who will be free to place their bids at any price with in a specified
price band. In the current version of bookbuilding unlike in the U.S. the price band is not freely
determined by BRLM only the lower price limit will be specified by the BRLM then the upper price
level is automatically capped at 120% of the lower price. So the BRLM has the freedom only to choose
the lower price limit (floor level). However the issuer has the freedom to revise the lower price limit
±20% (in which case the upper price will also be revised automatically as 120% of the revised lower
price limit) and the issue has to be kept open for a further period of 3 days.
At first instance this 20% cap seems to be constraining the freedom of the BRLM however
Ljungqvist et al., (2000) report that the average width of the indicative price range of 3,480 IPOs by
U.S.-based issuers between January 1992 and July 1999 had an average width of 16.2% so the SEBI
determined upper level seems to be an adequate price range and may not be a restraining feature.
In the U.S. only institutional investors will be invited to participate in the bidding process but in
India even retail investors (at present defined as one who is investing not more than Rs 1,00,000 in a
particular public issue) can also participate in the bidding process. Moreover the retail investors have a
choice of the nature of the bids – they can place either market bids or limit bids while institutional
investors have to necessarily place limit orders. This is another difference compared with the U.S.
175 International Research Journal of Finance and Economics - Issue 38 (2010)

wherein institutional investors can place either market, limit or step bids. Another important difference
is the bids placed by institutional investors are binding but in the U.S. institutional investors place
nonbinding bids that can be revoked without attracting any penalties.
Once the bidding period is over the books are closed and the BRLM will decide the offer price
(in consultation with the issuing company) which remains the same for both the retail and non-retail
investors. As per the SEBI regulation currently in force out of the total shares to be issued 35% will go
for the retail investors; 15% for the non-institutional investors and 50% for the institutional investors.
All the retail investors and non-institutional investors will be allocated on a prorate basis from their
respective quotas while institutional allocations will be done at the discretion of the BRLM. As in the
U.S. the allocation basis for the institutional investors is not divulged in the prospectuses and almost all
issuers make the customary statements like “…allocation will be decided based on the quality of the
bidder determined broadly by the size, price and time of the bid”. However from November 2005 SEBI
made it mandatory that all allocations be made on a prorate basis to all types of investors.

3. Literature Review2
Shah (1995) documents an underpricing of 3.8% weekly excess returns from a study of 2056 IPOs that
commenced trading between January 1991 and April 1995 and finds that past Sensex returns have an
impact on the underpricing. In a comprehensive analysis of 1922 IPOs listed from 1992 to 1995
Madhusoodhanan and Thiripalraju (1997) shows that the annualized excess returns from IPOs at
294.8% was higher than the experiences of the other countries. They also suggest bookbuilding as an
alternative “proposition to avoid mispricing”. Kakati (1999) examined the performance of a sample of
500 IPOs that tapped the market during January 1993 to March 1996 and documents that the short run
underpricing is to the tune of 36.6% and in the long-run the overpricing is 40.8%. Krishnamurti and
Kumar (2002) working on the IPOs that listed between July 1992 to December 1994 conclude a mean
excess return of 72.34% and indicate that the time delay between offer approval and the issue opening
as an important factor behind the underpricing. Majumdar (2003) also documents short run under
pricing in India and observes after market total returns of 22.6% six months after listing.
All the above mentioned studies examined IPO performance during the fixed price regime as
bookbuilding was not in vogue at those times. Ranjan and Madhusoodanan (2004) from a study of 92
IPOs offered during 1999-2003 document that fixed price offers were underpriced to a larger extent
than the bookbuilt issues though the bookbuilt issues were only figuring 24 in the sample this was the
first study comparing the fixed price issues performance vis-à-vis bookbuilt issues. Bubna and
Prabhala (2007) studying data that spans over 2000-06 document that bookbuilt issues experience
lesser underpricing than fixed price offers, while the method loses its efficiency once the BRLM is
deprived of the discretionary allocation powers.
However the international evidence on the efficacy of IPO pricing of various methods is rather
mixed – Ljungqvist et al (2000) from a sample of 2051 offerings from different countries observe that
average underpricing of the fixed price offers at 20.5% fares similar to that of bookbuilt issues
underpricing of 20.1%. An examination across the regions showed that the average underpricing of
bookbuilt issues is more than those of fixed price offers for European issues while the opposite is true
for Asia and African/Middle eastern Countries. Though Ljungqvist et al (2000) conclude that bookbuilt
issues experience less underpricing they qualify this conclusion by adding that if the issue is managed
by an US investment banker in a senior role or when the issue is targeted at the US investors. Infact
they remark that markets outside the US may have not learned how book building operates. Derrien
and Womack (2003) examined the French IPOs over the period 1992 – 98 offered through
bookbuilding, fixed price offer and the auction modes. They document the underpricing levels as
16.9%, 8.9% and 6.5% respectively thus concluding that auctions are a better way of pricing IPOs.
Busaba and Cheng (2002) modeling the pre-market together with the aftermarket shows that unless the

2
For an excellent review of IPO literature see Jenkinson and Ljungqvist (2001) and for the Asian literature Yong (2007)
International Research Journal of Finance and Economics - Issue 38 (2010) 176

Underwriter targets a small group of informed investors a fixed price offer is less costly than a
bookbuilt offer and the former method can maximize the issue proceeds. Kaneko and Pettway (2003)
based on IPO performance in Japan conclude that IPO returns from bookbuilt issues are significantly
higher than those of auctions.
From the literature review we can infer that there is mixed evidence on the efficacy of
bookbuilding, which is mainly evaluated in terms of underpricing and the Indian studies are not an
exception. This study contributes to the Indian IPO literature by analyzing the following:
1 Unlike the earlier studies in India that examined the efficiency of IPO issuing mechanisms by
focusing only on underpricing alone this work attempts to re-examine the issue by taking into
consideration both direct (issue management expenses) and indirect costs (underpricing). Since
what matters to a company is not only reasonable pricing of the issue but the net proceeds - net
of issue expenses and underpricing.
2 Further this study examines another unexplored issue in Indian markets - the performance of
IPOs that were lead managed by syndicates comprising US based investment bankers vis-à-vis
those managed by Indian BRLMs alone.
3 Finally we analyze the determinants of issue expenses verifying whether issue size alone
determines it or other factors also have a bearing on it.
Our study addresses the following research questions – firstly as can be noted from the past
studies in Indian IPO market bookbuilt issues were found to be less under-priced than fixed price offers
therefore in this study we set out to find whether bookbuilding method still retains its superiority after
considering the issue expenses? Only after considering the issue expenses one gets a complete picture
of the efficiency of these methods from an issuer’s perspective. Ljungqvist et al (2000) find that though
bookbuilt issues are less under-priced they are more expensive than fixed price offers because of higher
issue expenses. The second question is how does the IPOs lead managed by US based BRLMs fare vis-
à-vis IPOs lead managed by other BRLMs? International evidence shows that IPOs lead managed by
U.S. underwriters experienced lesser underpricing (see Ljungqvist et al 2000).
Lastly, the determinants of the IPO issue expenses are explored. More specifically we are
interested in finding out whether bookbuilt issues are more expensive than fixed price offers and
whether the presence of US based BRLM makes any difference to the issue expenses?

4. Data Description
This study spans the time period between January 2003 and December 2007 our sampling unit is an
IPO that is listed either on Bombay Stock Exchange (BSE) or National Stock Exchange (NSE) using
either fixed price offer or bookbuilding mechanisms during this period. From the bookbuilt issues we
had omitted those that were issued during Jan 2003- Nov 2005 as in this period SEBI permitted
discretionary allocation powers to the BRLMs and from Nov 2005 this was withdrawn. As this
provision is not available today for the issuers we have excluded those issues consequently our sample
size of bookbuilt issues is 157 and the size of fixed price offers is 51. The fixed price offerings list on
the BSE website formed the main source of fixed price offers and the NSE’s list of companies that
used the bookbuilding route formed the basic database for bookbuilt issues. From these lists we
omitted all the follow on public offers, withdrawn issues, and cancelled issues after which we were left
with 208 companies over the five year period and the year wise break-up of the sample is given in
Table 1:
177 International Research Journal of Finance and Economics - Issue 38 (2010)
Table 1: Year wise break-up of the sampled IPOs

Year FPO BB
2003 1 -
2004 8 -
2005 13 10
2006 15 58
2007 14 89
51 157

We also collected the Final Prospectuses of the IPO companies from SEBI’s website. We
collected the capital structure, post-issue promoters holding, issue expenses and the Lead Managers to
the issue from the Final Prospectus that was filed with SEBI. The listing price is obtained from the
exchange’s web sites where the scrip traded first, (in almost all cases there is no listing lag between
NSE and BSE) in case a scrip is listed only at BSE we used prices from BSE otherwise almost all the
listing prices were obtained from NSE, Nifty index was considered as the proxy for market returns.

5. Methodology
We computed two measures – the returns usually calculated in the IPO literature raw returns (Rit) and
are defined as under
⎛ P − Oi ⎞
R it = ⎜⎜ it ⎟⎟ × 100
⎝ O i ⎠
Where Pit is the opening (listing) price of stock ‘i’ at time‘t’ and Oi is the offer price of the ith
stock. These returns measure whether an investor gained (or lost) by buying the shares during the IPO
at the offer price and selling at the opening price on the listing day. If Rit is positive one can infer that
the issue is under-priced; if Rit is negative it may be inferred that the issue is over-priced and if Rit is
zero it means the issue is aptly priced.
Following Ritter (1987) we computed the total costs associated with the IPOs in the following
way
⎛ Issue size − Issue expenses ⎞
TC = 100% − ⎜⎜ ⎟⎟
⎝ Listed price × No. of shares ⎠
To find whether total costs of fixed price offers are different from bookbuilt offers we perform
regression analysis
Y = α + β. X + ε
Where Y represents the total costs (TC) computed as above and X is a matrix of the following
explanatory variables:
Age of the firm (age): We defined age of the firm as the year of incorporation subtracted from
the year of IPO. Older the firm more track record it has and lesser uncertainty is expected hence the
excess returns ought to be less. Megginson and Weiss (1991) find that age is negatively related to the
listing returns of the IPO.
Bookbuilt (Bblt): This is a dummy variable that assumes zero if the issue is a fixed price
offering and assumes ‘1’ if the issue is bookbuilt. Theoretically bookbuilding should lead to lesser
underpricing hence we expect this coefficient to have a negative sign in the regression equation.
BRLM reputation (Ibrep): We define reputation of the BRLM by way of number of issues
handled prior to the issue in question the starting point being the year 1999 when bookbuilding actually
commenced in India. More the number of issues a BRLM has managed more experience he has in
pricing and marketing hence we expect lesser will be the underpricing. Generally each issue is
managed by more than one BRLM in such a case the Lead Manager who managed a higher number of
issues in the past is only considered. Carter and Manaster (1990) show that issues marketed by
prestigious underwriters provide less initial returns.
International Research Journal of Finance and Economics - Issue 38 (2010) 178

Concentration (Conc): We define concentration as the post issue shareholding of the promoters.
Since the promoters are likely to have more information about the prospects of their firm by retaining a
larger share they will be signalling of their quality of offering. A higher concentration may show the
commitment of the promoters leading to reduction in information asymmetry. Allen and Faulhaber
(1989) and Grinblatt and Hwang (1989) models show that promoter’s holding conveys information
about the quality of issues. Jaitly and Sharma (2004) found that offer prices are higher when
concentration is higher consequently lower underpricing.
Market Sentiment (Msenti): We define market sentiment as the returns earned on Nifty index
over a three month interval before the issue opening day. We expect a positive association between
IPO performance and market performance. McGuinness, (1992) shows that trend of the markets before
the issue is positively related to the IPO underpricing levels.
Size of the issue (Lnsize): The total rupee amount (gross proceeds) of the issue being offered to
the public is considered as issue size. We took the logarithm of the issue expressed in rupee terms. We
expect the size to have a negative sign as larger issues will be followed by a larger number of analysts
and less susceptible for price manipulation. Beatty and Ritter (1986) finds that there is a positive
relationship between inverse of gross proceeds and initial IPO returns.
Volatility (Vol): The ex post standard deviation of the IPO returns computed over 21 days after
listing is taken as proxy for the riskiness of the IPO. Higher the volatility higher ought to be the excess
returns. Ritter (1987) using a similar metric finds a positive relationship between after market volatility
and the IPO returns.
Leverage (lev): The pre-issue book value of debt divided by book value of all assets is taken as
a measure of the leverage of the firm. A higher leverage indicates the firm has to generate cashflows to
meet the debt service requirements and hence signals the quality of the firm and reduces the
information asymmetries. Kim et al (2008) find that leverage is a signal of quality for low-tech IPOs,
that for low-tech IPOs, and for high-tech IPOs, the effect of leverage is reversed.
US based BRLM (USBM): In our study we considered DSP Merrill Lynch, J M Morgan
Stanley, J P Morgan, Citigroup Global Markets India Private Limited, Lehman Brothers Sec. Pvt. Ltd,
as U.S. based BRLMs. The criteria used to define a BRLM as US based or otherwise is to check
whether the firm is either a subsidiary of a U.S. based investment banker (like J P Morgan India) or the
U.S. parent is a partner with an Indian merchant banker (like DSP Merrill Lynch).
Next we try to examine what factors determine the choice of the issuing method and this was
done by running the below mentioned Probit regression
Y = α + β. X + ε
wherein the dependent variable Y is a dummy variable that equals 1 if the issuer uses bookbuilding and
zero otherwise. ‘X’ is the matrix of independent variables explained earlier.

6. Results and Discussions

Table 2 presents some of the descriptive statistics of the issuing firm characteristics. One can note that
there is no significant difference in the age of the companies that opted for bookbuilding or fixed price
offers. Infact the average (and median) age of the bookbuilt issuers is more than that of the fixed price
offers. Although it needs to be mentioned that the mean age comes down slightly less (to 15.47 years)
than that of the fixed price issuers if we ignore two nationalized banks (Indian Overseas Bank and
Central bank) that went public during this period. The average age of the issuers is in contrast to what
was observed in the U.S. where companies usually go for their IPO when they are relatively young (see
Loughran and Ritter 2001).
179 International Research Journal of Finance and Economics - Issue 38 (2010)
Table 2: Summary statistics (n = 208)

Fixed Price Offers

size listing delay age Conc
Mean 283.8 28 14.98039 53.63%
Standard Error 4.348153 1.07061 1.626132 0.017584
Median 225.9 27 12 54.97%
Standard Deviation 31.05202 7.645683 11.61291 0.125573
Minimum 60 18 0 24.15%
Maximum 2300 61 69 76.77%
Count 51 51 51 51
Bookbuilt issues
size listing delay age Conc
Mean 3761.7 24 16.2293 60.97%
Standard Error 872.7518 0.349416 1.037783 0.012241
Median 1010 23 13 62.75%
Standard Deviation 1093.555 4.378171 13.00339 0.153379
Minimum 237.7 16 0 23.15%
Maximum 91875 58 100 89.99%
Count 157 157 157 157

There are significant differences between fixed price offer and bookbuilt issue sizes. The
median issue size in bookbuilt issues is around INR1010 mn while that of fixed price offer was around
INR225 mn one can note that most of the companies that used fixed price offer route are companies
with smaller issue sizes. There are not more than a handful companies with an issue size of INR500 mn
or more that used the fixed price method and companies with bigger issue sizes had used the
bookbuilding route. From the mean and median issue sizes it can be noted that because of some big
offerings the distribution is skewed. It may be noted that bulk of bookbuilt issues commence trading in
less than 23 days time while it is around 27 days for the fixed price offers. With regard to listing delays
associated with fixed price offers there seems to be significant decrease compared with yester years.
Earlier studies mentioned in the literature review report more than hundred days of listing delays. The
favourable decrease in listing delay could be due to the changes that happened in the capital markets
over the last few years for instance dematerialization of shares. The decrease in listing delays
associated with fixed price offers is a welcome change.
Though the mean post issue holding of the promoters seems to be significantly different, the
distribution of the promoters holding shows that around 88% of the issuers had a post issue holding of
75% or less while for fixed price offers the shareholding is only 65% or less. One can infer that
bookbuilt issuers are going for lesser dilution than those in fixed price offers.

6.1. Underpricing and Listing Day Returns

A perusal of the listing day prices show that of the 51 fixed price offers 46 opened at a premium to the
offer price, one issue opened at the offer price and the rest four issues listed at a discount. While 130 of
the bookbuilt issues listed at a premium six issues listed at the offer price and 21 experienced listing
losses. Descriptive statistics (shown in Table 3) on underpricing measured as raw returns shows that
bookbuilt issues experienced less underpricing but once the stock returns were adjusted (Excess
Returns) for the market movements in the intervening period we do not find any difference between the
underpricing levels in either of the mechanisms. When the under pricing levels were examined for
FPOs and bookbuilt issues separately based on size by taking the samples of FPOs and bookbuilt issues
separately and using median issue size we divided each of the sub samples in to two - small sized
issues and large sized issues (shown in Table 4) we notice that smaller sized FPOs experienced more
underpricing (around 8.73%) than the larger sized FPOs but for bookbuilt issues there is no difference
in the underpricing levels between larger and smaller sized issues.
International Research Journal of Finance and Economics - Issue 38 (2010) 180
Table 3: Descriptive Statistics: Listing day returns, Total costs and Issue Expenses

Fixed Price Offers Bookbuilt offers

Listing Excess Issue Total Listing Excess Issue Total
Returns Returns Expenses Costs Returns Returns Expenses Costs
Mean 19.15% 15.72% 5.85% 25.00% 17.65% 15.39% 6.02% 23.67%
Median 20.00% 14.96% 5.56% 24.37% 15.91% 11.95% 5.77% 22.26%
S.D. 20.26% 19.95% 2.50% 18.67% 19.01% 18.63% 2.53% 17.64%
t-statistic 6.75 5.63 16.70 9.56 11.63 10.35 29.78 16.82
P value 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
Minimum -59.96% -64.96% 0.95% -47.38% -29.50% -27.33% 0.35% -21.11%
Maximum 66.67% 57.35% 13.71% 69.52% 90.57% 86.91% 17.28% 91.46%
Count 51 51 51 51 157 157 157 157

Table 4: Issue Size and the underpricing levels

Fixed Price Offers Bookbuilt Offers

Small Large Small Large
Mean 0.201687 0.114417 0.152025 0.155783
Variance 0.036816 0.040375 0.031655 0.038156
Observations 25 26 78 79
Hypothesized Mean Difference 0 0
df 49 154
t Stat 1.586586 -0.12604
P(T<=t) one-tail 0.05952 0.449932

6.2. Total Costs

From Table 3 one can note that on an average FPOs seem to be slightly expensive for an issuer than the
bookbuilt IPOs but a standard t-test (assuming unequal variances) showed with a test statistic of 0.4464
that there is no difference (at conventional levels of significance 10%, 5% or 1%) between the total
costs under the two mechanisms. The higher underpricing noted earlier in the smaller issue sized FPOs
might had manifested as higher total costs for the FPOs as a whole. However this needs to be
confirmed after controlling for issue related and mechanism related factors. To see the impact of issue
size on total costs (shown in Table 5) we took the samples of FPOs and bookbuilt issues separately and
using median issue size we split each of the sub samples in to two small sized issues and large sized
issues. The smaller FPOs appeared to be more costly than the large sized FPOs by around 7.67% but
the difference is statistically significant at only 10% however we didn’t find any difference in the total
costs for small as well as larger bookbuilt issues. We also noted that smaller sized issues were typically
managed by less repute lead managers and bigger sized issues were typically managed by more repute
lead managers. This is based on the fact that median number of past issues managed by a lead manager
is 1 for smaller sized FPOs and 5 for the book built issues while the median number of past issues
managed for large FPOs is 1.5 while the same for bookbuilt issues is 11.

Table 5: Analysis of Total costs

Overall Fixed Price Offers Bookbuilt Offers

FPOs BB Small Large Small Large
Mean 0.249963 0.23671 0.289046 0.212383 0.23517 0.238232
Variance 0.034841 0.031099 0.035979 0.032146 0.031401 0.031195
Observations 51 157 25 26 78 79
Hyp. Mean Difference 0 0 0
df 81 49 155
t Stat 0.446425 1.482125 -0.10844
P- two-tail 0.656482 P one-tail 0.072355 P one-tail 0.456892
181 International Research Journal of Finance and Economics - Issue 38 (2010)

6.3. Issue Expenses

The issue expenses are the direct expenses associated with any public offering. Generally they
comprise Lead Manager’s fee, underwriting commissions, printing and stationery, Monitoring agency
fee, Registrar’s fee, Legal fee, Agency fee, Advertising and marketing fee, and IPO grading expenses
(optional). The average issue expenses (shown in Table 3) for FPOs were at 5.85% and for the
bookbuilt issues they were at 6.02%. We didn’t find any statistically significant difference between the
costs under the two different mechanisms (shown in Table 6), as the t-statistic at -0.4156 is not
significant at conventional levels of significance (10%, 5% or 1% levels). This finding is contrary with
what was observed by Ljungqvist et al (2000) – the direct costs of bookbuilt issues around 4.5% is
more than that of fixed price offers at 2.3%.We examined the issue expenses for FPOs and bookbuilt
issues separately using the median size as the differentiator. For the FPOs the issue expenses for
smaller issues is lower than those for the larger issues by around 1.01% and this difference is
significant at 10% level while for the bookbuilt issues smaller issues are more costly than the larger
issues by around 2.16% which is significant at 1% level of significance.

Table 6: Issue Expenses

Overall Fixed Price Offers Bookbuilt Offers

FPO BB Small Large Small Large
Mean 0.058492 0.060173 0.053352 0.063435 0.071019 0.049464
Variance 0.000626 0.000641 0.000339 0.000874 0.000648 0.000409
Observations 51 157 25 26 78 79
Hyp. Mean Difference 0 0 0
df 86 42 147
t Stat -0.41564 -1.46793 5.870531
P- two-tail 0.678709 P- one-tail 0.074787 P - one-tail <0.00001

6.4. Results from Multiple Regressions

We regressed the total costs against the firm specific variables like age, concentration, leverage and
volatility; issue related factors like size of the issue, issue mechanism, reputation of the lead manager,
listing delay; and market related factors like market sentiment prior to the launch of the issue, market
movements between the closure of the issue and the listing of the stock. From the regression if the
bookbuilding is a better mechanism for an issuer to raise capital we will find that the bookbuilt dummy
will be statistically significant with a negative sign. The regression results presented in the Table 7
below shows that only three variables are statistically significant – issue size, market movement
between the issue closure day and the listing day and the market sentiment (proxy for hot/cold markets)
prior to the launch of the issue. We didn’t find the bookbuilt dummy as statistically significant
indicating that there is no difference between the total costs incurred by an issuer whether the capital is
raised in the form of fixed price offer or as a bookbuilt issue.
International Research Journal of Finance and Economics - Issue 38 (2010) 182
Table 7: Total costs and issue mechanism (n = 208)

Coefficient Std. Error t-ratio p-value

const 0.342361 0.234469 1.4602 0.14584
Ibrep 0.00343191 0.00235777 1.4556 0.14710
indrets 0.621131 0.180457 3.4420 0.00071
vol -0.406536 0.460329 -0.8831 0.37824
lnld 0.00577972 0.068385 0.0845 0.93273
lnsize -0.0244516 0.0134055 -1.8240 0.06967
age -0.000812076 0.00106755 -0.7607 0.44775
lev 0.00780424 0.00541179 1.4421 0.15087
Conc -0.132679 0.0899324 -1.4753 0.14172
msenti 0.261759 0.129255 2.0251 0.04420
bblt 0.0290298 0.0375093 0.7739 0.43990
Adjusted R2 = 0.07064 F-statistic (10, 197) = 2.57327 (p-value = 0.00601)

We examined for the time fixed effects by including a dummy for the year of issue and we find
no time fixed effects. The variance inflation factors indicated that there is no multi-collinearity3. We
also explored whether any interaction effects are present by including combined effects of
bookbuilding and issue size but the regression results shown in Table 8 indicate that the interaction
term (sizeint) is not statistically significant. Similarly we looked at the interaction of bookbuilding and
reputation of lead manager (Ibint term) on total costs (results presented in Table 9) which is also not
found to be statistically significant.

Table 8: Total costs and issue mechanism with interaction effects of size (n = 208)

Coefficient Std. Error t-ratio p-value

const 0.587822 0.291845 2.0142 0.04536
Ibrep 0.00295923 0.00237584 1.2456 0.21442
indrets 0.621358 0.180011 3.4518 0.00068
vol -0.399013 0.459222 -0.8689 0.38597
lnld -0.0103353 0.0691718 -0.1494 0.88138
lnsize -0.0861213 0.0458485 -1.8784 0.06181
age -0.000885673 0.00106619 -0.8307 0.40716
lev 0.0111922 0.00591164 1.8933 0.05980
Conc -0.137383 0.0897725 -1.5304 0.12754
msenti 0.263994 0.128945 2.0473 0.04196
bblt -0.186884 0.158035 -1.1825 0.23842
sizeint 0.0671019 0.047718 1.4062 0.16124
Adjusted R2 = 0.07522 F-statistic (11, 196) = 2.53071 (p-value = 0.00525)

3
Both the results were not reported for brevity and will be available up on request
183 International Research Journal of Finance and Economics - Issue 38 (2010)
Table 9: Total costs and issue mechanism with interaction effects of Lead Manager’s reputation (n = 208)

Coefficient Std. Error t-ratio p-value

Const 0.365247 0.235925 1.5481 0.12320
Ibrep -0.00748974 0.0122614 -0.6108 0.54201
Indrets 0.61824 0.180566 3.4239 0.00075
Vol -0.406145 0.460535 -0.8819 0.37891
Lnld 0.00575251 0.0684155 0.0841 0.93308
Lnsize -0.0246928 0.0134142 -1.8408 0.06716
Age -0.000876778 0.0010704 -0.8191 0.41372
Lev 0.00736777 0.00543552 1.3555 0.17682
Conc -0.1367 0.0900816 -1.5175 0.13075
Msenti 0.269303 0.129579 2.0783 0.03899
Bblt 0.00689774 0.0447518 0.1541 0.87766
Ibint 0.0113219 0.0124733 0.9077 0.36516
Adjusted R2 = 0.06980 F-statistic (11, 196) = 2.41215 (p-value = 0.00784)

Next we proceed to examine whether the underpricing levels are different for the two
mechanisms by regressing the listing day returns against the firm specific, issue specific and market
related factors. Table 10 presents the regression results and here again we had not found the bookbuilt
dummy as statistically significant confirming the results of univariate statistics that the bookbuilding as
a price discovery mechanism fares similar to that of fixed price offers. But listing day returns threw
one interesting thing – reputed lead managers variable (Ibrep) is statistically significant and the
positive sign shows that more repute the lead managers are higher were the listing day gains. This
finding is counter intuitive as generally it is expected that more the number of issues managed by a
lead manager tighter will be the pricing as inaccurate valuation may lead to loss of business but the
regression results show to the contrary.

Table 10: Underpricing and issue mechanism (n = 208)

Coefficient Std. Error t-ratio p-value

Const 0.475957 0.519599 0.9160 0.36078
Ibrep 0.00946196 0.00522499 1.8109 0.07168
Indrets 0.94359 0.399905 2.3595 0.01928
Vol -0.482691 1.02012 -0.4732 0.63662
Lnld -0.0653721 0.151546 -0.4314 0.66667
Lnsize -0.00256258 0.0297076 -0.0863 0.93135
Age -0.00215401 0.00236576 -0.9105 0.36368
Lev 0.0103402 0.0119929 0.8622 0.38963
Conc -0.00923934 0.199297 -0.0464 0.96307
Msenti 0.157055 0.286438 0.5483 0.58410
Bblt -0.0408091 0.0831232 -0.4909 0.62401
Adjusted R-squared = 0.06712 F-statistic (10, 197) = 2.48946 (p-value = 0.00784)

This is followed up with the analysis of issue expenses – we regressed issue expenses
(percentage terms) over the following variables age, concentration, leverage, bookbuilt dummy, market
sentiment, issue size, volatility and a dummy for lead manager reputation.
International Research Journal of Finance and Economics - Issue 38 (2010) 184
Table 11: Issue expenses and issue mechanism Jan 2003 – Dec 2007 (n = 208)

Coefficient Std. Error t-ratio p-value

Const 0.0686026 0.0320156 2.1428 0.03335
Ibrep 5.33903e-05 0.000320292 0.1667 0.86778
Vol 0.0404611 0.0628572 0.6437 0.52052
Lnld 0.0047011 0.00933743 0.5035 0.61519
Lnsize -0.00914018 0.00182163 -5.0176 <0.00001
Age 4.77122e-05 0.000145389 0.3282 0.74313
Lev -0.00085479 0.000737426 -1.1592 0.24779
Conc 0.00885705 0.0122505 0.7230 0.47054
Msenti 0.200951 0.134333 1.4959 0.13630
Bblt 0.0176241 0.00509733 3.4575 0.00067
Adjusted R2 = 0.12967 F-statistic (9, 198) = 4.42684 (p-value = 2.71e-005)

We find two variables to be statistically significant – issue size, and bookbuilt dummy. The
sign of the variables indicate that the issue expenses decrease as the size of the issue goes up probably
because of the presence of higher proportion of fixed costs. We also note that the bookbuilt dummy is
positively related indicating that issue expenses are higher with bookbuilding than for fixed price
offers. As the bookbuilt dummy was found to be statistically significant we examined the issuance
costs for both the mechanisms separately to estimate the behavior of issuance costs. We premise the
issuance costs are a non-linear function of the issue size and started off fitting a cubic function using
OLS regression with the issue expenses (in rupee terms) over issue size (rupee terms) and higher
powers of the issue size for both fixed price offers and the bookbuilt issues separately. From the
regression statistics we notice that neither a cubic function nor a quadratic function does fit well for
issue expenses of fixed price offers and a linear function does the job. While for the bookbuilt issues
we noted that a cubic formulation explains well. The average costs for the FPOs (Figure I) are higher
for smaller issue sizes are gradually decreasing and plateuing as the issue size increases.

Figure I

Average cost behavior - Fixed Price Offers

0.21

0.2

0.19

0.18

0.17
AC

0.16

0.15

0.14

0.13

0.12
10 20 30 40 50
Issue Size in Rs. Cr.

Table 12: Dependent variable: fiexpabs (Issue expenses in rupee terms)

Coefficient Std. Error t-ratio p-value

const 0.519658 0.118383 4.389635 6.04E-05
fsize 0.05058 0.002829 17.87686 4.11E-23
Adjusted R Square = 0.864345039 F-statistic (1, 49) = 319.5821703 (p-value < 0.00001)
185 International Research Journal of Finance and Economics - Issue 38 (2010)
Table 13: Dependent variable: bbiexpabs (Issue expenses in rupee terms)

Coefficient Std. Error t-ratio p-value

const 1.26298 1.49023 0.8475 0.39804
Size (S) 0.0623284 0.00558849 11.1530 <0.00001
Ss (S2) -1.44291e-05 2.14324e-06 -6.7324 <0.00001
Sss (S3) 1.10534e-09 1.8419e-010 6.0011 <0.00001
Adjusted R2 = 0.76290 F-statistic (3, 153) = 168.32 (p-value < 0.00001)

For the bookbuilt offers the cubic formulation denotes that the curve plotted between issue
expenses and issue size is “S” shaped with the constant (β) and the coefficients of size (β1) and size3
(β3) having positive signs and the size2 (β2) term with a negative sign. However the coefficients fail to
meet the conventional condition β 22 < 3β 1 β 3 to observe the typical U-shaped Marginal and average cost
curves. The Average costs (Figure II) and the Marginal costs (Figure III) show that the marginal cost
curve is roughly U-shaped and the average cost curve is a sort of L shaped curve with the average costs
falling due to the presence of higher fixed costs or might be due to variable costs increasing at a
decreasing rate as the issue size increases. More insights in to the issue expense behavior are obtained
by using sophisticated techniques like Splines, which we are leaving for future researchers.

Figure II

Average Cost versus Size (Bookbuilt issues)

0.14

0.12
Average cost in Rs. Cr.

0.1

0.08

0.06

0.04

0.02

0
0 1000 2000 3000 4000 5000 6000 7000 8000 9000
Issue Size in Rs. Cr.

Figure III

Marginal Costs versus Size (Bookbuilt issues)

0.08

0.07

0.06
Marginal Costs

0.05

0.04

0.03

0.02

0.01

0
0 1000 2000 3000 4000 5000 6000 7000 8000 9000
Issue Size in Rs. Cr.
International Research Journal of Finance and Economics - Issue 38 (2010) 186

Finally we examined the presence of US based Lead Manager in the syndicate and the
corresponding total costs4 (Table 14) and issue expenses (Table 15). The regression results showed
issues that were managed by syndicates with US based Lead Managers fared no better than those
without them in their syndicates both on total cost front and on the underpricing levels.

Table 14: Pricing efficiency of US based Lead Managers (n = 208)

Coefficient Std. Error t-ratio p-value

const 0.396041 0.23631 1.6759 0.09534
indrets 0.601402 0.179966 3.3418 0.00100
vol -0.488557 0.457709 -1.0674 0.28710
lnld -0.00636929 0.0681389 -0.0935 0.92562
lnsize -0.0295575 0.0156609 -1.8873 0.06058
age -0.000850135 0.00106902 -0.7952 0.42743
lev 0.00862165 0.00541327 1.5927 0.11283
Conc -0.107728 0.0890404 -1.2099 0.22778
msenti 0.259506 0.129689 2.0010 0.04677
bblt 0.0452952 0.0373977 1.2112 0.22728
usbm 0.0457786 0.0392177 1.1673 0.24450
Adjusted R2 = 0.06709 F-statistic (10, 197) = 2.48869 (p-value = 0.00786)

Table 15: Issue expenses and the presence of US based Lead Managers (n = 208)

Coefficient Std. Error t-ratio p-value

const 0.0714899 0.0321743 2.2220 0.02742
vol 0.0392073 0.0623155 0.6292 0.52996
lnld 0.00441804 0.0092773 0.4762 0.63444
lnsize -0.00984138 0.00212542 -4.6303 <0.00001
age 5.45173e-05 0.000145237 0.3754 0.70779
lev -0.000826439 0.000735029 -1.1244 0.26222
Conc 0.00950391 0.0121061 0.7851 0.43336
msenti -0.0305056 0.0176057 -1.7327 0.08470
bblt 0.0182694 0.00505386 3.6150 0.00038
usbm 0.00348376 0.00533671 0.6528 0.51465
Adjusted R2 = 0.13142 F-statistic (9, 198) = 4.48 (p-value = 2.29e-005)

Finally we endeavored to find out what factors determine the choice of the issuing methods by
running a Probit regression. The bookbuilt dummy (Bblt) is the dependent variable and volatility,
listing delay, size, age, leverage, concentration, and market sentiment as the explanatory variables. The
results shown in Table 16 indicate that issue size, listing delay and BRLM’s reputation are statistically
significant factors. The signs are also as expected – more reputed the lead manager higher the
probability the issue will be bookbuilt and larger the issue size more likely the issuer will choose
bookbuilding. Longer the listing delay less probable the issuer will choose bookbuilding.

4
When we replaced total costs with listing day returns the results remained the same hence were not presented here but are
available upon request
187 International Research Journal of Finance and Economics - Issue 38 (2010)
Table 16: Determinants of the likelihood of using Bookbuilding method

Coefficient Std. Error t-ratio p-value

const -2.35137 3.45604 -0.6804 0.49627
vol 5.04365 5.36247 0.9405 0.34694
lnld -1.76068 1.02401 -1.7194 0.08554
lnsize 2.29459 0.41452 5.5355 <0.00001
Age -0.0245933 0.0162904 -1.5097 0.13112
Conc -0.777296 1.41094 -0.5509 0.58170
Msenti -1.31132 2.20753 -0.5940 0.55250
Ibrep 0.164373 0.0569835 2.8846 0.00392
McFadden's pseudo-R2 = 0.691444 Number of cases 'correctly predicted' = 194 (93.3%)

7. Conclusions
This paper attempts to examine the total costs associated with IPOs using the Indian IPOs that tapped
the capital markets during 2003-07. Earlier studies have documented that bookbuilt issues experience
less underpricing vis-à-vis fixed price offers and apparently bookbuilding was considered as a better
mechanism. However from an issuer’s perspective a mechanism is efficient only if it leads to higher
net proceeds i.e., benefit of better pricing (lesser underpricing) minus issue related expenses
consequently we attempt to find the efficiency of bookbuilding considering total costs. We computed
the total costs by considering both the direct as well as indirect costs associated with the public issues.
We find that from a total cost point of view the issuers are neither better off nor worse off using either
bookbuilding or the fixed price offers. This is evident not only from univariate statistics but also from
multiple regressions after controlling for the firm and issue related factors. We conjecture that
bookbuilding method might have lost its ability to discover the prices because of the lack of
discretionary allocation powers previously vested with the Lead Managers. Size of the issue, listing
delay and the reputation of the BRLM are found to be the important determinants while choosing the
IPO issuing mechanism. Unlike in the US our analysis showed that employing US based BRLMs do
not translate in to higher issue proceeds. Neither their issue-pricing skills nor the costs of using their
services are significantly different from those of Indian BRLMs.
International Research Journal of Finance and Economics - Issue 38 (2010) 188

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