Global Trends in IPO Methods: Book Building vs. Auctions with Endogenous Entry

Abstract

The U.S. book building method has become increasingly popular for initial public offerings (IPOs) worldwide over the last decade, whereas sealed bid IPO auctions have been abandoned in nearly all of the many countries in which they have been tried. I model book building, discriminatory auctions and uniform price auctions in an environment where the number of investors and the accuracy of investors' information is endogenous. Book building lets underwriters manage investor access to shares, allowing them to: 1) reduce risk for both issuers and investors; and 2) control spending on information acquisition, thereby limiting either underpricing or aftermarket volatility. Since more control and less risk are beneficial to all issuers, the advantages of book building's allocational flexibility may explain why global patterns of issuer choice are surprisingly consistent. My models also predict that offerings with higher expected underpricing will have lower expected aftermarket volatility; that an auction open to large numbers of potential bidders is vulnerable to inaccurate pricing and fluctuations in the number of bidders; and that both book built and auctioned IPOs will exhibit partial adjustment to public information.