The optimal offer mechanism for controlling under pricing of IPOs in Pakistani capital market

Abstract

This empirical study determines whether Fixed Price Offer Mechanism or Book Building Offer Mechanism is useful for pricing of the Initial Public Offerings (IPOs) in capital market of Pakistan or not.This research will contribute towards better understanding for the dynamics of Pakistani capital market for the companies which are intending to get themselves listed at the stock exchanges of Pakistan. To determine the optimal Offer Mechanism between the Fixed Price Offer Mechanism and Book Building Offer Mechanism, the IPO pricing in Pakistan was studied since the promulgation of the Book Building Regulations in 2008. Since the introduction of the Book Building Offer Mechanism as an alternative to the Fixed Price Offer Mechanism, the issuance of capital by the new companies through this mode of offering is getting pace with each passing year. This is mainly due to its inherent feature of price discovery by the well informed institutional and high net worth investors. Since promulgation of the Book Building Mechanism till today witnessed 36% of the total IPOs came through this mode. But it cannot be concluded that Book Building Offer Mechanism has fully superseded the Fixed Price Offer Mechanism for IPO pricing. The underpricing was measured by First day return. The descriptive statistics was used to empirically test the optimal Offer Mechanism for controlling underpricing of 22 IPOs during the years 2008 till 2013. From the empirical analysis it was concluded that Fixed Price Offer Mechanism controlled the underpricing of IPOs as compared to Book Building mechanism. The findings of this research are consistent with the findings of literature wherein Fixed price offer mechanism controls underpricing to a greater extent (Sherman, 2005; Derrien& Womack, 2003). These findings are in contradiction with the findings of other researchers regarding Book Building Offer Mechanism as optimalfor controlling underpricing (Bubna&Prabhala, 2008; Sherman, 2005; Cornelli&Goldreich, 2001; Sherman, 2000; Benveniste& Wilhelm, 1990).