Asian Financial Crisis of 1997
The Asian financial crisis was another major currency crisis that happened during the 1990’s. The crisis assumed epic proportions. This is because it started in only one country i.e. Thailand whose currency faced an attack from speculators. However, in a very short span of time the crisis had gripped the entire South East Asian region. […]
Disadvantages of Defined Contribution Pension Plans
Defined contribution plans have come under a lot of criticism because of the various disadvantages that they have. Many of these plans have been viewed as a covert way to absolve the government of any responsibility related to the retirement of its citizens. Given the many other socio-economic factors which are at play, defined contribution […]
Mining Pools in Cryptocurrency
In the previous article, we have already learned about the “Proof of Work” mechanism which underpins Bitcoin and many other major cryptocurrencies across the world. In any proof of work-based cryptocurrency, every transaction is validated by a miner. The transaction gets added to the blockchain only after such a validation takes place. However, we also […]
Reverse Mergers
The profession of investment banking has become quite innovative over the years. Traditionally, raising capital was an expensive as well as time-consuming process. However, over the past few years, investment banks have devised ways to help their clients raise funds. These ways are neither time consuming nor expensive. A reverse merger is one such innovative […]
Multi-Currency Accounts
In the globalized world of today, it is common for a business to go international. Almost any company which has a sizeable turnover has to deal with suppliers and vendors from across the globe. It is true that businesses receive the benefits of such expansion. However, there are also certain costs which are associated with […]
Book building has been one of the most widely used methods in the underwriting process. However, over the years, companies have realized that the book-building process is largely controlled by the intermediaries, i.e., the investment banks! The investment banks are the ones building the books. Hence, they can easily control who gets in and at what price.
Over the years, many companies raising capital have alleged that investment banks are corrupt, and many of them do not work in the best interests of their clients. Many companies learned this the hard way. For instance, the technology company Netscape was priced at $28 per share during the IPO process. However, as soon as the share was listed, it zoomed to $75 per share! Similarly, twitter was priced at $26 per share, whereas it went up to $46 per share after listing. In essence, Twitter, Netscape, and many other companies like them were simply leaving money on the table! Instead of companies raising this money during the IPO, secondary market speculators were making humungous profits by flipping the shares.
Over the years, this has led investors to doubt the entire system. In the above case, either investment banks were completely ill-informed that they could not gauge the price for which the stocks could actually be sold. Or, they were hand-in-glove with the speculators and were not acting in the best interest of their clients. The loss of trust in the book building system has led companies to search for alternative modes of price discovery, and the Dutch Auction is one of those modes. In this article, we will have a closer look at what the dutch auction process is and how it helps to overcome the shortcomings of the book building process.
Over the years, many firms have alleged that investment banks collude with investment funds while selling shares during an IPO process. This is because these funds hire the services of these investment banks in other forms and often pay them millions of dollars throughout the year. Hence, even though the bank is charging money from the client, they are often just doing the bidding of the investment fund! These investment funds, in turn, buy at low prices offered by the banks and then flip the shares on the day of the IPO for a higher price. This is why there is so much trading seen on the day of the IPO. Almost all the shares change hands the day these companies get listed.
The end result is that the investment banker and the investor make a killing. On the other hand, the company loses money since it raises much less than it would otherwise have. Also, genuine retail investors lose money since they get to buy stocks only at inflated prices. The root of this problem is that the investment banker has a lot of control over the IPO price.
The Dutch auction process of underwriting helps in solving this problem. This is because it takes away some of the control that investment bankers have in the price-fixing process. As a part of the dutch auction, companies solicit bids from prospective investors. The final issue price is decided based on the actual bids received. Hence, the chances of mispricing happening are quite low.
Also, the dutch auction process has been designed in such a way that it encourages investors to bid higher prices and raises the proceeds of the IPO. Let us understand the Dutch auction process with the help of an example:
Example: Company A wants to sell 300 shares. It has asked investors to bid for the shares and has received four bids.
Notice that the company wants to sell 300 shares. Hence, if it were to sell only to investor B, its supply would not be exhausted. If it sells to C as well, then too, it sells 200 shares only. However, when the company sells to investor D, it ends up selling more than 300 shares. There are two points to be noted here.
The bottom line is that even though book building is still the most popular underwriting method today, it is facing competition from the Dutch auction method, which many believe is more popular.
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