A Joint Experimental Analysis of the Dutch Auction, Book Building and Competitive IPO Pricing Methods

Abstract

We examine the differences of three IPO pricing methods jointly: book building, employed worldwide, the Dutch clock auction, routinely cited as an alternative to book building, and the competitive IPO, a recent innovation, tested in a few offers in Europe. We employ experiments with South American subjects who are bank professionals or business students. The main result is the characterization of book building as a pricing method that mostly benefits individual investors at the expense of the issuer and the selling shareholders. The competitive IPO, on the other hand, was the method that gave the best results for the issuer and selling shareholders, at the expense of investors. The competitive IPO, however, showed more dispersion of initial returns and evidence of the bait-and-switch strategy, which may be disguised in book building offers but is clearly exposed in the competitive IPO. Issuers could benefit from regulation or private contracting that favor the competitive IPO if its procedure discourages baiting-and-switching. Moving towards the competitive IPO may not be in the interest of underwriters and their clients. Moreover, this work adds on efficiency literature presenting analysis covering pricing efficiency, seller allocative efficiency and social welfare efficiency in IPOs. We find that auction is more social welfare efficient. Concerning pricing efficiency, learning seems to favor book building. Book building exhibited greater price formation stability and lower dispersion of initial returns after learning. Results also contradict the argument of Sherman and Titman (2002) that accuracy in the offer pricing leads to larger initial returns.