The mechanics of determining the offer price during the CCI regime was to offer share at a fixed price. Here, the firm and the merchant banker decide an offer prize without taking into account the investor’s feedback. Fixed price offerings are made to uninformed investors. Moreover, there is a long time lag among the date of pricing, the date the issue opens, and the date when trading commences. This raises the possibility of price fluctuations in the intervening period. Empirical evidence supports the view that fixed price offering results in high cost of capital for firms due to under pricing of shares for attracting subscription.
The pricing pattern changed in the free pricing era. This era was characterized by unrealistic and abrupt pricing structure, which stripped the radiance of the capital market. Investors shield away from the market after burning their fingers in those premium issues that are now being quoted not only below their issue price, but even below their par value.
Following the inefficient functioning of the capital market system, an alternative method, called the book building method is slowly becoming popular in India. Book Building is a mechanism through which an offer price for IPOs based on the investors demand is determined. In the fixed price method, the investors’ demand for shares at various prices is an important input to arrive at an offer price.
Globally, book building is a recognized mechanism or capital raising. It was book building which built the US market almost entirely in the 1940s and 1950s.
Book Building is basically an auction of shares:
i) The company first of all appoints a book runner, that is, a merchant banker
ii) The book runner prepares and submits the draft documents to SEBI and obtains an acknowledgement card.
iii) The issuer and the book runner decide to offer shares at a price within a specified price band (range)
iv) Offers regarding the demand for securities at different price levels are invited from syndicate members consisting of eligible brokers, merchant bankers, underwriters, financial institutions, mutual funds, and others. The advertisement should mention the opening and closing dates for the bids. A bid is usually open for a minimum of five working days.
v) Based on the bids received, the issuer arrives at a final cut off rate and the final allocation in consultation with the book runner and lead manager
vi) The issuer and the book runner may impose restrictions on the number of shares that can be allotted to each client so as to avoid any take over threats.
vii) The final prospectus is filed with the Registrar of Companies (ROC) along with the procurement agreement
viii) The placement portion opens for subscription only after the prospectus is filed with the ROC.
ix) The placement portion closes a day before the opening of the public issue portion.
x) The public portion opens and the allotment and listing of this portion is done. The price determined in the book building process is applicable to the public portion are well. If the public portion stands oversubscribed then the allotment is made on a proportionate basis. In case, the public portion remains undersubscribed, the shortfall is distributed amongst those who have opted for placement. If the placement portion is undersubscribed the size of the public issue is enhanced.
Thus, book building enables issuers to reap benefits arising from price and demand discovery. The aim of the process is to have the issue pre-sold and preclude chances of under subscription /devolvement and so on. The cost and time for making public issues is lowered; the procedures are also simplified.
The public issue benefits investors as they can trust the price at which the syndicate members have purchased the shares. Due to this, the possibility of price falling below par after listing is remote.