Fixed price and book building methods in an exogenous environment: Evidence from Indonesia stock market

Abstract

Book building has become a popular method of selling new shares. Although previous models suggest that book building is an efficient method for price discovery in initial public offering (IPO) issuance, empirical evidence provides mixed results. Previous empirical findings on IPO methods have been obtained from markets that allow issuers to choose the IPO method, and this setting is not free from endogeneity issues. We investigate the effect of IPO method (fixed price vs book building) in Indonesia, which is an emerging market that offers an exogenous setting for IPO methods. More specifically, Indonesia used the fixed price method for IPOs before October 2000 and used the book building method thereafter following the introduction of new IPO regulations. Using estimation methods that consider clustering phenomena, we find that book building yields larger underpricing and greater volatility than the fixed price method. Moreover, a positive relationship is observed between underpricing and aftermarket volatility for the book building method and book building IPOs underperform fixed price IPOs. No relationship was observed between underpricing and long-term performance for book building IPOs. Compared with previous models, our findings suggest that book building does not represent a quality IPO method and suffers from agency conflict; thus, this method needs improvement.