Efficacy of price discovery through book- building in the Indian primary markets

Abstract

Every bull phase in the stock market brings with it a plethora of initial public offerings (IPO).Promoters wait for the opportune moment to offload their shares to the public who are eager to grab a slice of the next ‘hot issue’. In the last three years, the Indian primary markets have seen an unprecedented number of public issues. In the first 7 months of 2006, 52 companies offered their shares to the public compared to a total 0f 43 in 2005. Most of these new issues have seen high investor interest with multiple over subscriptions. Much of this interest has been driven by the fact that almost all public issues today are under priced. Of the 36 IPOs in 2006 (till date), 27 were under priced with a total mean under pricing of 24.44%. Similarly,25 of the 31 IPOs in 2005 were under priced with mean under pricing of 22.35%.IPO under pricing in itself is not new.Financial research is rife with evidences of new issue under pricing. Research by Loughran, Ritter, and Rydqvist (I994) shows varying levels of under pricing in different markets throughout the world (See Table l). This paper will not restrict itself to the study of under pricing alone but will look at the broader process of ‘Book-building’ used in the price discovery of IPOs.The objective of the paper is to look at empirical data on public issues in India in the last 5 years, in particular the last two years and understand the true efficacy of price discovery through the book-building method. The paper will also look into the regulatory framework currently in place and try to provide policy alternatives that could help reduce the extent of systematic over/under pricing of public issues in India. the paper is divided into six sections. Section 1 describes the book - building procedure currently in practice in the Indian primary markets. Section 5 looks at alternative models of price discovery followed elsewhere in the world. Finally, section 6 looks provide policy guidelines that could help improve the price discovery process.