Topic: Book-Building Mechanism in India: The Built-in Inefficiencies.

Authors: Rachna Banerjee Source: Advances in Management; Nov 2009 Volume: 2, Issue: 11 Reviewed By: Suneesh l (B5-29) Abstract: This article mainly focuses on analyzing the efficiency of the book building mechanism which is adopted by issuers for pricing of the IPOs in India. Book building concept was first introduced in the year 1995. At that time, most of the developed countries used to fix the price of the IPO through this process. In the year 1999, book building was introduced in India, in a form that doesnt allow complete freedom and discretion available to lead managers as in U.S. In the book building process in India, the issuer sets a base price and price band which is not present in U.S & other developed countries. Individual as well as institutions take part in the book building process. The high net worth individuals and institutional investors invest in a large way mainly at the upper band to get the maximum allotment. Due to this imbalance in the demand and supply, the cutoff price is always at the higher end of the band. This leads to an inappropriate price determination. This overpricing can be easily seen in the short term market prices of these shares. In most of the IPOs, the market prices are trading way below their issue prices which clearly indicate that book building is not an efficient mechanism of price discovery. So, in order to prove that there is a significance difference between the issue price and the closing price of the IPOs, two tailed t-test was conducted with the data of the IPOs made during the period of 2005-2007. Random samples have been used to draw the samples of IPOs. T-test of the following data showed p value of 0.00 as compared to the level of significance as 0.05, which proved the null hypothesis (H0: there is no significant difference in the Issue price as well as closing prices of the IPOs) wrong. And then in order to check whether the average issue prices were higher than the average closing prices of not, a one-tailed t-test was conducted which proved that the average issue prices were higher. So, it clearly indicates that the price discovered by the book building process is mostly more than the intrinsic value. This might be the reason why most of

the small investors stay away from IPOs. The overpriced IPOs create a bad feeling in the investors mind as initial returns to them may be negative at that point of time. Statistics clearly shows that out of the 159 book-built IPOs in India between 2005-2007, only two-third saw listing gains. These figures have eroded sharply in the recent years. So, there is definitely some problem with the existing process of book building process with regard to IPOs. Some or the other changes must be made regarding this for better valuation of the IPOs.