Price Setting Mechanisms

Abstract

This chapter analyzes the main price-setting mechanisms in security offerings, focusing on the most common practice, i.e., the open-price approach, better known as book-building. The price-setting mechanism is just a step in the whole offering process. However, the way the price is set is crucial, being the price the key variable of any offerings, both for debt and equity. The role of the investment bank is strictly related to the price setting mechanism. Indeed the process of a bond issue is not really different from that of an equity issue. Though, how difficult is pricing a bond issue compared to an equity issue? And within equity issues is it that difficult to price a seasoned equity offering (SEO), for which a publicly available market price already exists? In other words, the role of the investment bank tends to be even more crucial in IPOs, where the price is more “uncertain”. This is also why investment banking fees are much higher in IPOs than in any other security offering. The IPO process, the role of the investment banks involved in the transaction, the fee they get paid and many other aspects of an IPO depend on the kind of price-setting mechanism used.