What is Book Building?

Definition

IPO pricing refers to the process by which underwriters attempt to determine the price of an initial public offering (IPO). The underwriter, usually an investment bank, invites institutional investors, such as fund managers and other investors, to submit the number of shares they wish to purchase and the price they are willing to pay, thereby creating a book of demand for the IPO.

Origin

The concept of IPO pricing originated with the development of stock markets, particularly in the late 20th century, as global capital markets expanded and IPOs became a crucial way for companies to raise funds. The role of underwriters evolved from merely selling shares to helping companies determine a fair offering price.

Categories and Features

IPO pricing can be categorized into fixed pricing and book building. Fixed pricing involves setting a predetermined price before the IPO, agreed upon by the underwriter and the issuing company. Book building, on the other hand, involves determining the price through market demand inquiries, often reflecting market conditions more accurately. Fixed pricing is straightforward but may not fully capture market demand, while book building is more flexible but complex.

Case Studies

A notable example is Alibaba's IPO in 2014, which used the book building method and was priced at $68 per share, becoming the largest IPO globally at the time. Another example is Facebook's IPO in 2012, which used fixed pricing at $38 per share, but due to overestimated market demand, the stock experienced significant volatility post-listing.

Common Issues

Common issues investors face when participating in IPO pricing include assessing whether the pricing is reasonable and managing the risks of overpricing or underpricing. It is generally advised for investors to pay attention to market feedback and the historical performance of the underwriters to make more informed decisions.