A Dissection of Bookbuilt IPOs: Subscriptions, Underpricing, and Initial Returns

Abstract

Certain unique characteristics of the Indian bookbuilding process allow us to study the timing and subscription pattern of different investor groups and to dissect the IPO returns into two distinct components: one relating to pre-listing underpricing set by the underwriter and the initial return from first day's trade in the post-listing period. The transparency of the bookbuilding process in India alleviates the winner's curse problem for the uninformed investors and we find that non-institutional buyers follow institutional investors' subscription patterns when bidding for the IPO shares. However, Indian IPOs still exhibit significant positive initial return in the post-listing aftermarket, even after the removal of the underwriters' power of discretionary allocations to preferred institutional clients. These results are inconsistent with Rock's (1986) winner's-curse explanation for positive IPO initial returns and also with that of Benevineste and Spindts' (1989) preferred allocation/information extraction quid pro quo model. We find that the IPO initial return is driven primarily by the unmet demand of the noninstitutional investor groups and consider these results to be generally supportive of Derrien (2005) and Ljungqvist, Nanda and Singh (2006).