How IPO Pricing Method Affects Underpricing and Issue Cost: Evidence on Japan's Change from Auction Method Pricing to Book-Building

Abstract

In 1997, Japan introduced a US-style book-building method of IPO pricing as an alternative to an open-market auction method that had been required since 1989. Shortly after its authorization, all IPOs in Japan were priced by book-building. The shift occurred despite economic arguments and evidence suggesting that the auction method reduced underpricing. In this paper, we examine the effects of the regime change on underpricing, total issue cost, and characteristics of firms that raise equity capital by IPO. We find that book-building enabled larger and better-established firms to reduce issue costs. The earlier requirement to use the auction method, as implemented in Japan, tended to foreclose smaller and less well-established issuers from the market. The shift to book-building in Japan appears to have been value-enhancing for large and small issuers, and a matter of indifference for issuers who lie between these extremes.