Difference Between Fixed Price Issue and Book Building Issue

An IPO is a strategic move for growth-driven companies wanting to raise capital for business expansion. As we learned, companies sell their shares to retail investors during this process. However, we have yet to discuss the crucial aspect of IPO pricing.   

In this chapter, we’ll discuss the two primary methods for pricing an IPO - the fixed price and the book-building issue. Before we go into the details, let us understand the historical context of how such processes evolved.

A Timeline of Indian IPO Pricing Mechanisms 

The history of India's stock market is fascinating, where raising capital from the public markets has undergone significant changes. From the rigid nature of fixed prices to the more dynamic -  book building, the evolution of IPO pricing mechanisms traces our nation's economic aspirations and changing financial landscape in the backdrop.

Let's start the journey from the beginning of the past. We’ll cover the significant milestones that brought us to the current times.

1947-1995: The Era of Fixed Prices

• Post-Independence Period: Although the financial markets existed during this time, India's capital market in the 1940s and 50s lacked the regulations, infrastructure, and pricing mechanisms familiar to more developed economies. Due to the lack of a more sophisticated pricing mechanism, a fixed-price solution emerged, where the company and merchant bankers pre-determined the issue price. This is how the Fixed Price Mechanism became the simplest form of pricing an IPO. It provided a certain sense of accuracy and simplicity in the earlier days of the financial ecosystem. While the fixed price made everything look simple, there were still some unforeseen problems. 

• Inaccurate pricing became a common issue: Companies that went public during this era often did not possess enough market or economic data to determine reasonable valuations, and this meant that they generally either underestimated or overestimated the value of their shares. This mostly led to underpricing scenarios where the large institutions quickly snatched shares before reaching any retail investors. This also led to overpricing scenarios, resulting in unsold shares, leaving companies with unsuccessful fundraising goals and weakening investor confidence. 

• Limited Participation: Slowly, the nature of the fixed price mechanism started discouraging broader investor participation, particularly individual retail investors spooked by the pricing issues. Retail investors were excluded from the process without influencing pricing or potential returns. This created a perception that the fixed price mechanism was decided by the institutions for their benefit.

Both these problems restricted capital access for companies and created an overall slowdown in the development of the public markets. Despite all the challenges and limitations, the fixed-price era was crucial in laying the groundwork for future development.

However, as the market matured, the limitations of the fixed-price system became clear. This paved the way for a complete shift in the pricing approach, as all the investors involved in the process now wanted a more efficient and transparent way to price an IPO. 

To deal with this, a committee was formed and was expected to come up with a solution. 

1995: The Y. H. Malegam Committee Report 

Due to the limitations of the fixed price mechanism, the Y. H. Malegam Committee report suggested a new change in how IPOs are priced in 1995 and made structural changes to the entire system. 

The committee recommended adopting a completely new pricing mechanism for IPOs. They suggested that this had the potential to solve the three major issues back then, which were improving price discovery, promoting greater investor participation, and increasing the overall efficiency of the process. 

That is when the book-building issue was first introduced in India. 

The fixed prices were static and did not provide any real element of price discovery, but this new mechanism offered dynamic pricing, allowing both institutional and retail investors to submit bids within a specified price range instead of one fixed price. In the book-building issue, the final issue price is determined based on the aggregate demand of different prices (within a specified price band)  at which the bids are placed by the investors who subscribe to the IPO. This process leads to a much more efficient measure of investor sentiments. 

With the combination of greater transparency and flexibility, the book building issue promised to unlock new possibilities for Indian IPOs and expand the primary markets.

1996-2000: From Pilot Project to Mainstream Practice - Book Building Takes Root

Following the committee's recommendations, the book-building issue was initially introduced on a pilot basis for a few selected IPOs. 

The pilot projects proved successful, showing signs of improved price discovery and investor participation. 

The early success paved the way for broader adoption. By the late 1990s, book-building had become the preferred pricing method for most IPOs. 

The capital market witnessed significant growth, with book-building pivotal in helping companies raise capital through IPOs.

As book-building became the norm, it went through constant refinement. The rapid digitisation of the country paved the way for electronic bidding platforms to replace manual processes, streamlining the entire system and improving transparency. Simultaneously, the regulatory frameworks were strengthened to stop potential risks and ensure fair practices. This laid the foundation for a robust and reliable book-building system in India. 

Another big change that helped overhaul the entire scenario of how public markets worked was the strong regulations set by the Securities and Exchange Board of India (SEBI). They brought in transparency, digitised most processes and made sure that retail investors now have equal access to the primary markets. 

2000-Present: Continuous Refinement 

The regulatory framework surrounding book-building has continued to evolve to tackle more sophisticated challenges, such as manipulating bids and information asymmetry between institutional and retail investors, leading to unfair practices. 

SEBI has also tremendously upgraded its skills. Now, it is a developed and accurate regulator that recognises the need to establish an equal ground to protect all investors’ interests, which should be evenly distributed.

The different new technologies created a revolution, too. Online interfaces have also revolutionised the method of initial public offering. Mobile apps have boosted ease of access, increasing investor participation and a higher level of financial inclusion.

One such case study for intermediate to understand the subtlety where changes were observed was by including anchor investors. These investors purchase a chunk of IPO shares, creating more stability, transparency, and confidence on the side of traders.

Nevertheless, even though so much was accomplished, problems still exist. The information asymmetry between institutional and retail investors is a distinct problem, emphasising the need for more transparency. Moreover, market volatility policies can also be adjusted to stimulate competition and widen prices. 

In recent years, AI and machine learning programs in building books may contribute to more efficiency and analysis. This, in turn, creates ethical challenges on the possible biases promoted and propagated towards manipulation.

The journey from fixed prices to book building reflects a remarkable transformation in the Indian IPO landscape. This was a summary of the history of IPO pricing, and you must have understood the meaning of the Fixed price mechanism and book-building issue. 

However, to get a formal understanding, let us look at each method individually. 

Fixed Price Mechanism

• Pricing

After evaluating its financials, the underwriters and merchant bankers of the company set a fixed price for its shares. This price is determined before the IPO is launched.

• Bidding Period

During the IPO period, investors submit bids at the predetermined price set by the company.

• Allotment

Allotment is based on demand at a fixed price. Investors who bid at or above this fixed price may receive allotments. Example - ABC Ltd decided to go for an IPO and announced a fixed price of ₹100. Investors interested in participating in the IPO submit bids at this fixed price, and allotments are then made based on the demand at ₹100, with refunds issued for unallotted shares.

• Table: Fixed Price Example

Fixed Price (₹)	Bids Submitted (₹)	Allotment
100	101, 100, 102	Yes
	95, 98	No

Book Building Process

• Pricing

Unlike the fixed price method, the company does not fix the IPO price in advance. Instead, it announces a price range within which investors can bid during the IPO period.

• Bidding Period

Investors submit their bids at different prices within the specified range. This process takes time, usually 3-7 business days.

• Price Determination

The final issue price is calculated at the end of the bidding period. This calculation relies on the weighted average method, considering the share demand at various price levels.

• Allotment

Investors who bid at or above the final price may receive allotments, while those who bid below the final price receive refunds. Example - XYZ Ltd announced a price range of ₹75 to ₹80 for its IPO. Investors bid within this range, expressing their willingness to purchase shares. The final price, say ₹78, is then determined based on the demand. Investors bidding at or above ₹78 may receive allotments, with refunds issued for the excess amount.

• Table 1: Book Building Example

Price Range (Rs)	Bids Submitted (Rs)	Final Price (Rs)	Allotment
75 to 80	78, 79, 80, 81	78	Yes
	76, 77,75		No

Book Building vs Fixed Price

You must have understood the two major methods of pricing IPOs by now. For better understanding, Given below is a quick comparison between the fixed price mechanism and the book-building issue. 

Difference Between Book Building IPO and Fixed Price IPO

Parameters	Book Building IPO	Fixed Price IPO
Price Determination	Dynamic pricing based on bids during the IPO period	Predetermined fixed price before the IPO opens
Prospectus	Red Herring Prospectus with a price band	Detailed prospectus with a fixed price
Demand Discovery	Daily insights into demand as the book builds	Demand is known only after the closing of the period
Payment	Initial blocking of funds, final amount collected	Upfront payment for applied lots
Reservations	QIBs, non-retail, and retail reservations	50% of shares reserved for applications below ₹2 lakh

How To Apply for IPO on Angel One?

1.  Login to the Angel One App or website and click on ‘IPO’ on the homepage.
2. Select the IPO you are interested in.
3. Go through the IPO details like maximum quantity, maximum investment, about the company, etc.
4. Click on ‘Apply Now’ to apply and enter the number of lots and bidding price along with your UPI ID.
5. Confirm your bid and accept the payment mandate sent to your UPI App for successfully completing the IPO application.

That’s it! Your IPO order is placed. You can check the status of your IPO in the ‘Order Book’ section.

Conclusion

As the market continues to evolve with greater participation than ever, the book-building issue continues to gain popularity for its dynamic approach, where the price is discovered through market sources. This approach also enables companies to gauge investor sentiments and try to get better valuations, fostering a more active and responsive IPO ecosystem.

Now that you understand what IPOs are, the process, and the types of IPOs, it is time to learn how to invest in IPOs, but how will you know which IPO to invest in? 

We’ll answer this question in the next chapter, where you will learn about the red herring prospectus and understand the qualitative and quantitative factors required to assess an IPO.