Suitability of IPO Pricing Methods to Overcome Underpricing: A Comparative Study in Bangladesh

Abstract

Initial Public Offering (IPO) mechanism gives a part of ownership of companies to small savers and enables investors to contribute to the economic development. This paper explores selected techniques by which companies going to public vary substantially across the world in the most studied market. In Bangladesh, there are two main methods of IPO pricing. One is Fixed Price (FP) method and another is Book Building (BB) method. It is difficult to isolate the impact of book building method relative to fixed price method which is used by the companies to go public. The empirical evidence demonstrates that most of the companies enter into capital market through FP method and BB method is the current issue in the capital market of Bangladesh. This study analyzes the trends of underpricing, overpricing, and oversubscription in initial public offerings (IPOs) listed in Dhaka Stock Exchange (DSE) and to what extent on a year to year basis. After introducing BB method in Bangladesh, 91 companies were listed in DSE during 2008-2015 except mutual fund and bond, out of which 87(95.60%) IPOs were listed through FP method and only 4(4.40%) were listed through BB method, and 89 (97.80%) IPOs were found to be underpriced, only 2 (2.20%) were overpriced while nothing is accurately priced. This research reveals that book building method may diminish the degree of underpricing and also compact the variance of over subscription considering all factors relating to IPOs in Bangladesh.

Keywords: IPO, Fixed Price Method, Book Building Method, Primary Market, Underpricing.