2003.12

Why Does Book Building Drive Out Auction Methodsof IPO Issuance? Evidence from Japan-Revised version of No2002・12-

Kenji Kutsuna
Richard SmithWhy Does Book Building Drive Out Auction Methods of IPO
Issuance? Evidence from Japan(Revised version)

Kenji Kutsuna
Graduate School of Business Administration
Kobe University
Rokkodai 2-1, Nada, Kobe, 657-8501, Japankutsuna@rose.rokkodai.kobe-u.ac.jp

Richard Smith
Peter F. Drucker Graduate School of Management
Claremont Graduate University
Claremont, California 91711
909-607-3310
richard.smith@cgu.edu

JEL codes: G15, G24, G28
Keywords: IPO, public offering, book building, underpricing

1Why Does Book Building Drive Out Auction Methods of IPO
Issuance? Evidence from Japan

Abstract
We examine Japan’s 1997 introduction of book building as an alternative to an auction
method of IPO issuance that had been required since 1989. Despite its higher total issue costfor some issuers, all issuers in Japan now select book building. In contrast to auctioning,book building enables firms to be valued more accurately. Because the gains from moreaccurate valuation are partly redistributive, book building can drive auction-method offerings
from the market even if book building yields no aggregate benefit to issuers. Compared toJapan’s prior auction regime, we find that for large, well-established issuers, book building
reduces total issue cost. The auction regime is less costly for small issuers, but appears toforeclose some high-quality small firms from issuing. Although book building is more costly
for small issuers, the aggregate costs of book building and auctioning in Japan are similar.
Because cost estimates for auctioning do not reflect the effects of some firms not issuing andbecause book building yields other benefits associated with more-accurate valuation, theevidence from Japan’s market experiment favors book building over auction.

2

Why Does Book Building Drive Out Auction Methods of IPO Issuance?
Evidence from Japan *In the US, Japan, and other countries, initial public offerings (“IPOs”) are marketed andpriced by a negotiation method that includes book building. In regimes where firms can selectbetween book building and auctioning, issuers overwhelmingly select book building. Sherman(2002), for example, in a study of 44 countries, finds no instance of issuers regularly using an auction
unless regulation prevents or restricts using book building.1
Firms that seek to maximize net issue proceeds from an initial public offering may selectbook building in preference to auctioning for a combination of two reasons. First, assuming expected
aftermarket value is the same by either method, total issue cost of book building (including fees andunderpricing) may be less than total issue cost of auctioning. Second, even if issue cost is higher,
book building also may result in higher aftermarket value.
If book building is a more efficient way to provide information to IPO investors, it may resultin less underpricing than auctioning. As book building centralizes information production andprovides more information than can auctioning, investors may incur lower information costs andaccept compensatingly lower initial returns.

Book building also may result in more accurate

aftermarket pricing. Accurate pricing can have two effects. First, it can reduce information costs inthe months after the offering, which saving would yield higher aftermarket value. Second, moreaccurate pricing could cause some non-issuers that would have been undervalued in an auction
regime to go forward with issues in a regime where book building is permitted.

*

The authors are grateful to Bill Brown, Richard Burdekin, Art Danzau, Francois Derrien, Gerald Garvey, Michel Habib,
Eric Helland, Bruce Johnsen, Avner Kalay, Susumu Kurokawa, Mike Lemon, Uri Lowenstein, David Mayers, Chee Ng,
Tim Opler, Jay Ritter, Jim Schallheim, Ann Sherman, Janet Kiholm Smith, and participants in the Vanderbilt University
conference on Entrepreneurship on the Technology Frontier, the Japan Finance Association Meeting, the Financial
Management Association European Meeting, and finance workshops at Arizona State University, Claremont McKenna
College, University of California Riverside, and University of Utah for comments on earlier drafts. Masayoshi Takahashi
of Nomura Securities provided much useful information on the Japanese IPO market. The Ishii Memorial Securities
Research Promotion Foundation provided financial support.
1
Sherman (2001) provides a comprehensive multi-country survey of IPO offering regulation.

3

Understanding the reasons issuers select book building when auctioning is available isimportant. If, for each firm, the total issue cost of book building is lower and book building is more
informative, then, book building dominates auctioning as a low cost way of informing investors. Ifbook building is more expensive, even for some issuers, then the advantage of book building is lessclear. Issuers select book building on the basis of their private benefits. However, as we discuss
below, some of the benefits are redistributive across issuers. In a regime where both methods areavailable, every issuer may select book building even though, collectively, they would prefer anauction regime.
Opportunities to study the effect of book building’s introduction on issue cost and thedecision to go public are rare. We examine, as a market experiment, Japan’s 1997 introduction ofbook building as an alternative to an auction method that had been required since 1989. Within one
month after its introduction, all issuers in Japan were selecting book building, though auctioning stillis available as a choice. We find that the shift occurred despite book building’s higher total issue
cost for most issuers and higher fees for all issuers. Thus, savings of issue cost cannot explain theshift of all issuers to book building. Instead, it is necessary to consider the effect of book building’s
availability on net issue proceeds.
For IPOs, direct comparison of net proceeds by book building and auctioning is not feasible.
Instead, we study total issue cost, underpricing, and issuer characteristics to draw inferences about
differences in expected net proceeds between regimes where book building is permitted and regimes
where it is not. If, as we find, availability of book building causes some firms to incur higher issue
cost but auctioning causes some firms not to issue, then these effects must be weighed each other andagainst book building’s advantages of more-accurate valuation.
With respect to total issue cost, we find evidence of a scale effect. For large issues (by large,
well-established firms) by our estimates, book building is less costly than auctioning. For small
issues (by small and young firms) auctioning is less costly. However, it is not possible to measure4the costs of non-issuance in the auction regime. This factor is economically important, as ourevidence indicates that a material fraction of high-quality small firms opted not to issue in the auction
regime. Such firms may have foregone attractive investments, as a result. We exploit the findingthat large issues can be achieved at lower cost by book building to examine the extreme case ofwhether, even if auctioning did not cause non-issuance by any firm, aggregate total issue cost in our
sample of Japanese IPOs would be lower by book building.
If non-issuance causes a firm to forego attractive investments or to raise capital by a more
expensive means, an important issue for any country is whether an observable cost advantage ofauctioning is sufficient to overcome unobservable losses due to non-issuance and more accuratevaluation when book building is available.

Considering our sample of issues from 1995 through1999, based solely on observable issue costs, a majority of firms would have had lower cost if bookbuilding were not available, the simple average cost advantage of auctioning is 5.58 percent ofaftermarket value. However, although book building is more costly for small issues, it is less costly
for large issues. Consequently, weighting by issue size, the aggregate costs of book building andauctioning in our sample are approximately equal. The cost comparisons represent a lower bound on
the net benefit of book building, as they do not reflect auction-method opportunity losses associatedwith non-issuance or benefits of more accurate IPO valuation by book building. The net advantage
of book building to a country is sensitive to the characteristics of prospective issuing firms in themarket. In Japan, book building appears to have no aggregate cost disadvantage, and has the
additional benefits associated with more accurate pricing.
In addition to its economic significance for Japan, the world’s second largest equity capital
market, the evidence is relevant to the US, where experimentation is occurring in the opposite
direction (toward auction), and to countries that are considering which offering methods to permit.2

2

W R Hambrecht & Co. introduced its “OpenIPO” electronic underwriting service in 1999. Bids are treated as indicationsof interest, and shares are sold at a single price that is at or below the lowest winning bid price. Investors base their bids

5

Further, the study is relevant to the choice between negotiated and competitive bid offerings and tounderstanding the general absence of best efforts offerings. In competitive bid offerings (used mostcommonly for public debt issues), the underwriter’s role in pricing is limited in much the same waythat it is in auctions.3 In best efforts offerings, as in auction offerings, the underwriter is distanced
from making a credible representation about value. Instead, the issuer sets the price and investors
determine the quantities they will buy.4
In Section I, we related the choice between auction and book building regimes to the tradeoff between underinvestment in projects and overinvestment in information. In Section II, we
discuss our assumption that underpricing is a cost of information production. Section III contains
descriptions of the salient features of Japan’s auction and book-building methods. We describe thedata in Section IV and present the empirical analysis in Section V. Section VI discussion of ourfindings and some policy considerations.
I.

Information Production and Offering Method
Firms may have private information about the value of their existing assets and investment

opportunities.

If managers act in the interest of passive investors, Myers and Majluf (1984)

demonstrate that adverse selection can result.

High-quality firms may refrain from issuing.

Investors, therefore, infer from a firm’s announced intent to issue that the firm is low quality andon a prospectus that includes a filing range estimate of closing value. To date, only a handful of firms have gone publicusing the OpenIPO process.
See www.hambrecht.com. In at least one instance, the Andover.net IPO, shares werediscounted from the lowest successful bid price. This discounting can reward investor effort to generate information in amanner similar to underpricing of a book-built IPO.
3
Prospective underwriters compete by bidding net interest cost. In a study of the choice of method, Smith (1987) findsthat for risky debt issues, and during volatile interest rate periods, negotiated offering results in lower net interest cost.
Competitive bidding also sometimes is used for “bought deals” of seasoned equity, where the underwriter purchases theequity and assumes the risk of changes in market value until the shares can be resold.
4
Loughran, Ritter, and Rydqvist (1994) note that in best efforts offerings the offer price is set before information on
demand for the shares is acquired.

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revise their valuations accordingly. If high-quality non-issuing firms forego attractive investments,
Myers and Majluf describe the aggregate result as underinvestment.5
Auction methods of IPO pricing conform closely to the Myers and Majluf assumptions.
While specifics vary, a common feature is that auctions have no obvious low-cost mechanism thatenables issuers to convey private knowledge to the market. Further, even if some investors haveprivate information about issuers, auctions generally cannot reward them adequately for revealing
what they know.6 Some auction methods limit the ability of investors to use existing informational
advantages or to invest in information that could create an advantage. Japan’s auction method, forexample, does not permit bidding by insiders and severely limits the number of shares any party can
bid to acquire. The apparent objective of the restrictions is to create an environment where bidders
can presume they are symmetrically uninformed.
By centralizing production of information about an issuer, book building addresses
underinvestment. Though information published in an auction prospectus can be identical to that in a
book-building prospectus, for our purpose, the essential distinction between methods is the centrality,
in book building but not auctioning, of the underwriter’s role in establishing the price at which theshares are sold.7 It is not fundamental to our analysis whether this pricing is based on due diligenceor efforts to induce investors to generate information or reveal what they already know. The criticaldifference is that with book building the underwriter makes a credible representation of value,
whereas with auctioning no such representation is made.
However, book building increases the potential for issuers and underwriters to produce
information for redistributive gain, at the expense of other issuers. Hirshleifer (1971) demonstrates
5

Underinvestment is only one potential consequence of underproduction of information. Others can include resource
allocation errors based on inaccurate aftermarket valuation, inefficient efforts to produce information in the aftermarket,
reduced liquidity, and uncertain issue proceeds.
6
Sherman (2002) summarizes the literature on auction methods and concludes that underpricing is a natural result of either
discriminatory or single-price auctions. Sherman also notes that, in comparisons, auctions generally result in lessunderpricing. Comparisons of underpricing, however, do not control for underinvestment.
7
Under Japan’s auction method, which is a hybrid form, the underwriter also guarantees sale of remaining shares in a
public offer tranche that is priced at a discount from the weighted average auction price.

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that communities of individuals with identical preferences do not, as a whole, benefit from producing
information that contributes only to exchange. He concludes that pursuit of private benefits can leadto overproduction, even when information also has productive value. In an examination of financial
markets, Fama and Laffer (1971) conclude that either competitive or monopolistic production of
information for trading can result in overproduction. They observe that regulations that prevent firms
from producing information for trading can be value enhancing. However, they note that this also
may induce outsiders to produce information that the firm could have produced more cheaply, a
concern that Japan’s auction rules address.8
In our empirical analysis of total issue cost and selection of book building, we assume thatthe underwriter’s effort level devoted to pricing in a book-built IPO is a choice variable. In effect,
the issuer chooses from a schedule of fees and corresponding effort levels. Depending on issue
characteristics, firm characteristics, and the underwriter’s reputation and validation technology, theschedule maps into prices the underwriter is willing to certify.

Underpricing arises for two

interrelated reasons. First, to protect against litigation or reputational damage, the underwriter’s costof mispricing is skewed in favor of underpricing. Second, the underwriter trades off information
discovery effort against residual underpricing. If there are scale economies to the underwriter’sfunctions related to pricing, small firms with small issues will select greater expected underpricing.
We assume that the market understands the underwriter’s incentive to underprice and how effort
levels and targeted underpricing depend on observable characteristics of the issue, firm, andunderwriter.9
Because the underwriter can vary effort level and offer price continuously, the saving of issue
cost that auctioning may offer also may be achievable by a book-built IPO, particularly if little or no8

In a recent study, Barzel, Habib, and Johnsen (2001) examine syndication and show, that underpricing, rather than being
a payment for producing or revealing information, can be a rent for agreeing to remain uninformed.
9Models of IPO signaling rely on issuer choices of offering methods or terms as signals. In Leland and Pyle (1977),
ownership retention signals expected cash flows. Thakor (1982) provides a model of debt insurance that parallels ourreasoning. In that model, an issuer’s credit quality is revealed by the payment to a third-party insurer.

8effort is devoted to certifying a price above the expected auction price. 10 In this case, otheradvantages of book building may be sufficient to produce the commonly observed result that, whenboth methods are available, all issuers select book building.11
As some of the gains from permitting book building may be relative (issuers that would beundervalued by auction gain at the expense of those that would be overvalued) and because
prohibiting book building may result in underinvestment, one cannot rely on “the market test” toconclude that a regime where book building is permitted is preferred to a regime where it is not.
Instead, the central question is how issuers in a regime where book building is permitted would have
fared in a regime where it was not, and how issuers in a regime where only auctioning is permitted
would have fared if book building had been permitted.
II.

Underpricing as a Component of Total Issue Cost
In making inferences about possible overproduction of information, we use underpricing as

an estimate of a portion of dissipative issue costs, along with underwriter fees. This assumption isreasonable for both book-built and auctioned IPOs as long as prospective investors are symmetricallyinformed or if the number of investors with superior knowledge is not material to their decisions of
how much to invest in information. The assumption is most plausible for auctioned IPOs, especiallywhen auction rules exclude informed investors.

10

Heinkel and Schwartz (1986) were the first to model offering method as a signal. In their model, issuers select among
three methods based on the effort they want underwriters to commit to producing information and how optimistic they areabout value. Maksimovic and Pichler (1999) consider the choice between IPO and private placement. They argue thatpublic issues may be underpriced if producing information is costly and conclude that small issuers may be better off by
selling without generating much pre-sale information. Our consideration of policy distinguishes this study from moststudies of offering method choice. A noteworthy exception is Sherman (1999), who develops a model of shelf registration
as a mechanism that limits due diligence. Sherman’s model can account for several stylized facts related to seasoned
equity offers, including that the market reacts more negatively to shelf offer announcements and that riskier firms tend to
avoid shelf registration. Smith (1987) makes a similar argument and presents consistent evidence for debt issuers’ choices
to use competitive bid versus negotiation.
11
The underlying adverse selection reasoning may appear to imply that some firms would continue to issue by auction.
This is not necessarily true for two additional reasons that are present in our analysis. First, the firms that would issue byauction may, instead, elect not to issue. As such firms were simply free-riding in the auction regime, we do not investigate
this non-issuance as a cost of book building. Second, book building is not always more costly.

9

The nature of underpricing of book-built IPOs is less clear. If underpricing is a rent to
informed investors for revealing what they know, then total issue cost is partly a wealth transfer.
Rock (1986), Benveniste and Spindt (1989), and Benveniste and Wilhelm (1990) are among thestudies that model underpricing in this way.12 Alternatively, if underpricing is compensation for
producing information, then including underpricing as part of issue cost is correct. Sherman (2002)
models underpricing as compensation to investors for producing information about aftermarket
value. 13

Finally, underpricing can substitute for due diligence and certification costs that

underwriters otherwise would incur.

Booth and Smith (1986), for example, develop a model

whereby an issuer can increase expected net proceeds by engaging an underwriter who has invested
in reputation. The underwriter’s fee includes a quasi-rent that compensates for the prior investment
in reputation.14 In certification models, underpricing may be either a wealth transfer or compensation,
depending on, among other things, to whom the underpriced shares are allocated and what provisions
exist for the underwriter to recapture the underpricing gains.15
Because the measured costs of book-built IPOs may overstate dissipative costs, our treatmentof the costs as dissipative is another factor that biases our results in favor of auctions. We address
this through interpretation of the results.
III.

Japan’s IPO Pricing Experiments
Empirical studies of underpricing and issue cost are of three types. The first includes studiesof cross-sectional patterns within a regime where institutional features of the market are constant.
The second includes international comparison studies, where institutional features are different
12

For related empirical evidence, see Cornelli and Goldreich (2000). See, also, Sherman (2000).
In contrast to Sherman, we assume firms have private knowledge about their quality and that each desires to maximize
expected net proceeds. Concern about pricing accuracy is beyond the scope of our empirical analysis, but contributes tothe advantage of book building.
14
Tinic (1988) offers a similar model where litigation risk is the certification mechanism. Hughes and Thakor (1992)
formalize the model. Chemmanur and Fulghieri (1994) develop a dynamic model where reputation is associated with lessunderpricing but larger fees.
15
The Benveniste and Spindt model, for example, is, necessarily, a certification model where the underwriter’s fee
compensates for certification and underpricing is a rent to informed investors. See Benveniste, Busaba, and Wilhelm(1996) for discussion of the underwriter’s certification role in the context of Benveniste and Spindt.
13

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across countries. The third is focused on market experiments where, within a country, the regime haschanged. Market responses to regime changes can yield different information than the other two
approaches, and inferences of causality can be more compelling. We take our evidence from Japan’s
1997 introduction of book building, a well-documented experiment in a capital market with a highlevel of IPO activity.
The fixed (formula) pricing regime: Before April 1989, IPO issuers in Japan were required
to employ a fixed-price offering method.

The underwriter determined the offer price by amathematical formula specified by the Japan Association of Securities Dealers (“JASD”) and thestock exchanges. The formula was applied to the prices and financial data of a small selection of
public companies that the underwriter had identified as comparable. The offer price was computed
as the equal-weighted average of the relative earnings, dividends, and net assets of the publiccompanies, multiplied by average share price.16 The formula did not prevent systematic underpricing.
Pettway and Kaneko (1996) document average initial returns of 62.1 percent during the period, for asample of 110 IPOs on the Tokyo Stock Exchange. During this period, the underwriter controlled
allocations of oversubscribed IPOs.

For conducting the offering, the underwriter received acommission of approximately 3.5 percent.17
The auction regime: In 1989, following a political scandal related to underpricing, Japanabandoned the formula and implemented a formal tender process to determine the offer price. 18
Under the new hybrid auction procedure, the issuer designated a substantial portion of the issue (the16The required formula is documented in the report of Shoken Torihiki Shingikai (Securities and Exchange Council)(1989). The Council is advisory to the Japan Ministry of Finance. The Council proposes and recommends institutionalchanges for Japanese stock markets. The 1989 report addresses the shift to auction method.
17
Fees were fixed informally among underwriters at 3.5% plus two yen, paid from gross proceeds. According to the
Nomura Securities, fees were reduced by agreement to 3.1% plus two yen after January 1990. The percentage was not arequirement, but a common practice. After November 1994, the practice broke down and slightly higher fees of 3.3% to3.5% sometimes were charged. Until the 1997 change, regular meetings were held among top executives of the big four
underwriters. The meetings, called “Yonsha Kai” (Yonsha means four companies, and Kai means meeting) addressed
matters of importance to the industry. Yonsha Kai is now abolished.
18
Jenkinson and Ljungqvist (1996) report that Japan’s prime minister was forced to resign in April 1989, following
revelation that Recruit Company had attempted to buy political influence by selling off its Cosmos subsidiary in an IPO,
and directing allocations of greatly underpriced shares to public officials.

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“auction tranche”) to be offered directly via auction. During our study period, 50 percent of theshares were required to be offered by auction. The auction failed if less than 25 percent of total
shares were ordered.19 A preliminary prospectus was available before the auction, but contained no
information on pricing. Shares allocated to the auction tranche were offered using a “first-revised”
prospectus. This prospectus specified a minimum price below which bids would not be considered.
The minimum was based on a formula, similar to the earlier approach.20 During our study period theminimum permissible bid was 85 percent of formula value. This was a discriminatory auction where
each bidder paid the price they bid. At the close of the auction, shares were allocated to highest
bidders first, until the entire allocation was distributed or the minimum was reached.
Japanese regulations precluded insider participation in the auction. Also, by significantly
limiting the maximum number of shares any participant could bid to acquire, the regulations
discouraged institutional participation. Generally, a participant could bid to acquire no more than
5000 shares (5 round lots). At the average offer price in our sample, the maximum corresponds toabout 10 million yen, or about $100,000. Under these restrictions, incentives of investors to produce
information about value appear to have been very limited. Institutional investors generally did notparticipate in the IPO market during the auction regime.21
A few days after the auction, a formal underwritten offering of the remaining shares (the“public offer tranche”) would take place, using a “second-revised” prospectus and an offer price set
by the underwriter. The maximum price the underwriter could set was the weighted average price ofthe successful bids. The minimum could not be less than the minimum permissible bid, but more

19

See the report of Shoken Torihiki Shingikai (Securities and Exchange Council) (1995).
Under the auction method, the preliminary prospectus was available about 10 days before the minimum permissible bid
price was determined. The first revised prospectus became available on the day after the minimum was determined.
Three or four days later, a one-day auction occurred.
21
Based on a study of 110 JASDAQ IPOs in 1996, Tamura (1997) reports that institutions purchased 11.7 percent ofauction tranche shares and 13.7 percent of public offer tranche shares. Individuals purchased the remaining shares.
20

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often was constrained by the need to induce investors to bid in the auction. 22 The prospect ofacquiring more shares or shares at below the offer price encouraged bidding. Excessive free-riding
on price discovery was prevented (and institutional participation was effectively discouraged) bylimiting acquisition of public-offer-tranche shares. An investor could acquire no more than 5000
shares in the public offering (a total of 10,000 by both approaches) and could participate in no morethan four public offerings per year. However, by excluding insiders and significantly limiting thenumber of shares each purchaser could bid to acquire, Japan’s auction mechanism limited incentives
to devote resources to valuation and prevented insiders and other informed investors from directly
affecting offer prices.
Under Japan’s auction method, the underwriter’s role in IPO pricing necessarily is limited.
Prospective investors bid on the basis of information in the prospectus. While the underwriter canengage in due diligence to verify statements in the prospectus, the prospectus is an incomplete
snapshot of the issuer’s position and track record. Without damaging their prospects, issuers cannot
fully disclose intellectual property, strategic plans, or other proprietary information that could benefit
rivals. In addition, as Pettway and Kaneko establish for the fixed-price regime, the formula-basedminimum permissible bid in the prospectus cannot be very informative about the underwriter’s
assessment of value. Furthermore, the informal agreement among underwriters, during the auction
regime, to restrict fees to a low percentage, constrained the information production efforts
underwriters might otherwise have elected to make.23
Until late 1997, this auction procedure was the sole method permitted for determining the
IPO offer price. From the start of 1995 until introduction of book building, 321 JASDAQ firms used
the auction method to go public. In Table 1, we summarize information related to the auction
process for these IPOs. Overwhelmingly, issuers set the size of the auction tranche at the 50 percent
22

See the report of Shoken Torihiki Shingikai (1995). Additionally, before 2002, underwriters in Japan could not use
over-allotment options or over-sell as ways of assuring the success of an offering or to offset pricing errors.
23
See footnote 17.

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regulatory minimum. While our database does not include failed offerings, the sample evidence
suggests that failure of was rare or non-existent. The auction tranches of all but three issues in our
sample were fully subscribed or oversubscribed by auction bids. The lowest of the three that were
not fully subscribed still was 80 percent subscribed, well above the minimum necessary to prevent
failure of the auction.
As documented in the table, minimum permissible bids provided little guidance to investors.
In 87.5 percent of the cases the minimum is below the minimum successful bid.

Minimum

successful bids average 46.4 percent higher than the minimum permissible bids and are as much as516.2 percent higher. The median is 21.7 percent higher. Compared to average successful bids, thedifferences are even larger.
We also document the practice of discounting the price of the public offer tranche relative tothe weighted average successful bid. As an indication of the underwriter’s disengagement frompricing, 40.1 percent of the public offers are priced at exactly the minimum successful bid. In somecases where the offer price does not equal the minimum successful bid, the offer price appears simply
to reflect rounding.
The book-building regime: When Japan introduced book building, in September 1997, it did
not formally abandon the auction method, and still has not done so. Instead, it authorized bookbuilding as an alternative. 24 Under book building, the underwriter seeks indications of interest,
primarily from institutional investors. The underwriter determines the offer price in light of due
diligence and evidence on demand derived through pre-marketing.25 Under Japan’s book-building
method the offer price need not be linked to the values of comparable firms.

24

Beginning on September 1, firms could elect book building. Because of the time required to complete an offering, thefirst book-built IPO occurred on September 29. Based on Japanese regulation of offering procedures and discussion withpractitioners, the auction method still is available, but issuers do not select auction.
25
In Japan, the underwriter sets a minimum and maximum price before the roadshow. Institutional investors submit nonbinding price and quantity indications. The underwriter, in selecting the final offer price, can accept the quantity
indications above the price and sells any remaining shares to the public. For 17 IPOs by Nomura during the first quarter of
2002, an average of 15.4 percent of the shares were sold to institutions in Japan.

14

In contrast to the earlier change to auctioning, the 1997 regime change was not driven byscandal or other crisis. Various rationales were offered for the change. Among them: underwriters
needed more pricing discretion; the auction method’s discriminatory pricing structure discouraged
bidding, making it difficult to assess demand and limiting offer size; and, due to low institutional
involvement, pricing was more heavily affected by market conditions than by fundamental value.26
As an overlying consideration, introduction of book building was one aspect of Japan’s “big bang”
financial institution reforms. Japan was seeking ways to promote access to capital markets for earlierstage and riskier companies.27
Empirical implications: Because offer prices are based on auctions where investors have
limited information compared to issuers, Japan’s auction method can give rise to the Myers and
Majluf underinvestment problem, a separating equilibrium where high-quality firms neither issue nor
invest. However, pooling with all firms issuing also is possible, and is more likely in market
segments where the valuation errors from restricting information production are likely to be small.28
Empirically, this suggests that pooling is more likely among large and well-established firms andseparating is more likely among small firms and firms with limited track records.
To base the comparison of book building and auction strictly on differences in observed issuecost, it must be possible to assume that all firms that would issue by book building also would issue
by auction and that aftermarket value would be the same by either method. If so, then differences inissue cost would map directly into differences in net proceeds. However, as pooling is less likely
among small and risky firms, the assumption is not valid. Consequently, our comparisons are biased
in favor of the auction method, particularly for such firms.
26

These concerns are documented in the report of Shoken Torihiki Shingikai (1995) and by Nomura Securities.
In July 1995, a second over-the-counter (OTC) market was established to encourage early stage and high-technology
companies to seek equity. Book building was introduced experimentally in this market. In September 1997, it was
extended to all IPOs. Despite the initiative, only three young high-technology companies registered on the second market
between mid-1995 and 1998. The second market now has been absorbed into JASDAQ. See the report of Shoken
Torihiki Shingikai (1995) and Kutsuna, Cowling, and Westhead (2000).
28
Giammarino and Lewis (1988) and Cadsby, Frank, and Maksimovic (1990) identify three possible equilibria: pooling,sorting, and semipooling. They examine the conditions under which each attains.
27

15

If, as our evidence suggests, under Japan’s auction method, some high-quality small andrisky firms refrain from issuing, then aftermarket prices of small and risky issuers by auction willreflect their expected low quality. If pooling is more likely among large and well-established firms,
then aftermarket prices will reflect their expected average quality. Thus, for small and risky firms,
our analysis of issue cost underestimates the impact of the auction method on net proceeds. Had
pooling occurred, aftermarket prices of low-quality firms (those that did issue) would have been
higher, resulting in higher average net proceeds. For the firms that did issue, the unobservabledifference in aftermarket value is part of the true total issue cost of the auction method. In addition,
we cannot measure the value of lost opportunities due to underinvestment.
With book building, the underwriter is at the heart of offer pricing. The underwriter can use
the filing range to reflect the value implications of private information derived from due diligenceand the roadshow or through its long-term relationship with the issuer. High-quality firms selectbook building if the increase in aftermarket price due to being recognized as high quality is greaterthan the per-share cost of any additional expenditure on underwriter effort.
In the analysis of the cost of book-built IPOs, assuming that all firms issue, observed
aftermarket prices should reflect average firm quality. Thus, in contrast to the auction regime, we areable to measure the full cost of book building. Consequently, estimates of cost difference between
book building and auctioning are upper bound estimates of the advantage of auctioning. Because
auction method costs are underestimated and some book-building costs may not be dissipative, ifbook building is estimated to be less costly, then book building is preferred. However, if auction isestimated to be less costly, then the balance between the two depends on the underinvestment
opportunity loss, any real benefits of more accurate valuation, and benefits associated with thepossibility that book building affords greater certainty of proceeds.

16

IV.

Data
To study the regime change, we use a sample of 484 IPOs by companies that listed on the

primary JASDAQ market or one of the JSDA OTC markets during the five-year period from 1995
through 1999.29 In addition to the 321 auctioned IPOs discussed previously, the sample includes 163
book-built IPOs.30 We focus on JASDAQ instead of the Tokyo Stock Exchange (“TSE”) because
JASDAQ is the primary market for IPOs in Japan. Only 59 IPOs occurred on the TSE during thesame five-year period. IPOs on the TSE generally are by older and substantially larger firms. As therules regarding offering methods are the same, our evidence suggests that the TSE data would morestrongly favor book building.
We obtain financial data and issue data from the Research Group for Disclosure database(1996-2000). Firm data include sales revenue, equity book value, shares outstanding, firm age, andnumber of employees for the year before the offering. Issue data include the offer date, number ofshares issued, amount raised, offer price, first aftermarket price, and other offering details. Toyo
Keizai Inc. provides daily stock price data for JASDAQ companies. We use the daily JASDAQ
Index as a measure of overall market performance.
Issue cost: In Table 2, we contrast fees, underpricing, and total issue cost (fees plus
underpricing) for book-built and auctioned IPOs. Studies of fees and underpricing generally express
both as percentages of offer price (so underpricing is measured as an initial return). In Panel (a), we
follow this convention. However, this standardization has undesirable statistical properties. Because
initial returns are highly skewed, the measure heavily weights outliers that turn out to be severely
underpriced. Also, total issue cost conceptually is better measured as a transaction cost; i.e., thepercent reduction from market value to net proceeds.

29

The sample excludes four registrations of firms that were delisted from JASDAQ and three registrations on the second
division of the OTC. Departures are due mainly to merger and acquisition.
30
While the switch to book building quickly became universal, two firms used the auction method in the first month after
Japan authorized book building. We include them in the auction sample.

17

In Panel (b), we address the skewness problem by expressing total issue cost as a percent of
first aftermarket price. The measure is consistent with our discussion, which is focused on incurringissue costs to affect the aftermarket price, and yields distributions that de-emphasize positive outliers
and more closely approximate normality.
Table 2, suggests that Japan’s shift to book building led to much higher initial returns (70.81
percent versus 7.12 percent) and correspondingly higher total issue cost.

Measured against

aftermarket price, total issue cost of book-built IPOs averages 28.04 percent, compared to 8.17
percent for auctioned IPOs. However, the entire difference cannot be ascribed to book building.
Figure 1 illustrates that, although book building was introduced in late September 1997, there is no
readily discernable change in the typical level of underpricing until 1999.
To address the inference from Figure 1, that 1999 is a fundamentally different period, webase our analysis primarily on a subsample that excludes 1999. In a similar vein, because the IPO
market may have changed for reasons unrelated to introduction of book building, we exclude 1995
data from the subsample. The resulting three-year window, from 1996 through 1998, is a period of
relatively stable capital market conditions and is short enough to implicitly control for many factors
other than the regime change. Thus, in Table 2, we also report and test differences between post1995 auctioned IPOs and pre-1999 book-built IPOs. The difference in mean total issue cost between
these groups, though considerably smaller, is still highly significant. Much of the 8.30 percent
difference in total issue cost is traced to the difference in fees. However the 6.53 percent difference
in initial returns remains significant.
Capital market uncertainty:

Whether by auctioning or book building, the offering processincludes specification of a minimum bid price or a filing range that is established on the basis ofmarket conditions several weeks before the offering. During market runups, differences between

18

minimums or ranges and aftermarket prices are likely to increase. 31 Following market declines,
offers are more likely to be cancelled. Following runups, offers may go forward, but offer prices areunlikely to be adjusted fully.32 Hence, underpricing can increase.
Market runup partially explains the 1999 increase in underpricing. Figure 2 shows the
JASDAQ Index over the study interval. During the auction regime and through 1998, the Index
generally fluctuates between 40 and 60 and the overall direction of movement is negative. Bothfactors tend to limit underpricing. However, during 1999, the Index increases by more than 300
percent. The rapid percentage increases corresponds to the high initial returns in Figure 1.
In Panel (a) of Table 3, we report two measures of market runup. The first is the percent
increase in the JASDAQ Index over the 40 market days before the IPO. We use this as an indicationof the unexpected change in the market from around the time of the decision to offer until the time of
the IPO.33 The second measure is the percent increase from 100 market days before the IPO until 40
market days before. We use the latter measure as an indication of market performance preceding thedecision to offer. The table demonstrates that 1999 was a period of unusually rapid runup and thatthe post-1995 auction IPOs and pre-1999 book-built IPOs had similar market changes in the 40 days
before the offering.
Issuer track record: Underwriters and investors are likely to have more difficulty estimating
the market values of young and small issuers. Hence, underpricing and total issue cost may be larger
percentages of gross proceeds.34 Panel (b) compares the track records of issuers in our sample. Firmage, number of employees, equity book value, and sales revenue all are higher for auctioned than for31

Derrien and Womack (2003) study auctioning and book building in France and find evidence that during hot markets
auctioning is associated with less underpricing than book building. They attribute the result to the auction method’s ability
to incorporate more information about recent market performance into the offer price. Timing and other aspects of theFrench auction process are different from the Japanese process. Because auctioned and book-built IPOs are not concurrent
in Japan, we cannot assess whether their findings would apply in a similar way.
32
For book-built IPOs in the US, Hanley (1993) documents that offer prices adjust only partially to demand that is higher
or lower than the filing range in the preliminary prospectus.
33
Our use of day –40 as the approximate date of the decision to offer is based on judgment and general practice, as wehave no specific data for the IPOs in our sample.
34
Beatty and Ritter (1986) find a positive relation between ex ante uncertainty about value and underpricing.

19

book-built IPOs. Premoney valuation is an estimate of pre-issue market value and is calculated
based on the offer price. Median values are smaller for book-built IPOs, even though 1999 increases
in market prices contribute to higher values.
The above differences suggest that book building reduces informational asymmetry andunderinvestment by smaller and younger firms. Our evidence provides no support for an alternative(non-mutually exclusive) “hot market” view that the increased percent of small and young issuers
was caused by market runup during 1999. The evidence suggests that the higher average issue cost
reported in Table 2 for book building is associated with the higher proportion of IPOs by small andyoung issuers.
Underwriter market share and venture capitalist certification or market power: Panel (c)shows that the average underwriter market share of IPOs was higher during book building thanearlier. Thus, the industry became more concentrated. However, the regime change did not cause
the increase. Rather, it is due to the failure of Yamaichi, the underwriter with the fourth highest
share during the auction regime, and the concomitant increases in shares of the top three remaining
underwriters: Nomura, Nikko, and Daiwa.35 The cumulative share of the remaining 12 underwriters
remained constant at 19 to 20 percent.
Panel (c) also documents that the percent of offers with venture capital backing is higher
during book building than during auctioning.

This suggests that the change to book building

increased capital-market access for issuers that normally would attract venture capital. While thepercent with venture capital backing is highest in 1999, pre-1999 book-built IPOs also are
significantly more likely than auction IPOs to be venture capital backed.36

35

Kutsuna (1997) documents that underwriting in Japan is concentrated among a small number of large companies. In our
sample, the big 4 firms underwrote about 80% of auction IPOs: Nomura 32.7%, Daiwa 17.4%, Nikko 17.4%, andYamaichi 13.1%. After introduction of book building and the failure of Yamaichi, shares of the big 3 increased: Nomura
33.1%, Nikko 25.8%, and Daiwa 20.9%.
36
Loughran and Ritter (2003) document a secular increase in venture capital-backed IPO activity in the US. Allowing forsecular drift, we tested for a structural shift in our data, related to the hypothesis that venture capital backing is higher

20Offer size: In Panel (d), we examine relationships between pricing method and offer size.
Consistent with the implication of underinvestment, that removing the auction-method constraints
gave small issuers enhanced access to the capital markets, capital raised is lower under book building,but issue size relative to shares outstanding is significantly higher. This is true, particularly for thethree-year subsample, which is not distorted by the 1999 runup. The evidence implies that bookbuilding affords greater flexibility - small issues appear to be more possible under book building, as
are issues that are large relative to firm size.
V.

Empirical Analysis
The decision to issue: The hypothesis that the auction method results in underinvestment

implies that high-quality small and risky firms are less likely to issue in the auction regime than whenbook building is available. Consistent with the hypothesis, Table 3 documents that auctioning issuers
are older and larger than book-building issuers. While is not possible to identify firms that did notissue but would have if book building were available, descriptive data can be used to draw aninference about the number of firms that elected not to issue.
Table 4 presents results of four different estimates of the size of the non-issuer population
during the auction regime. The estimates are based on three assumptions. First, we assume that withregard to firm age or employment, the distribution of potential issuers is the same during auction as
during book building. Second, we assume that all prospective issuers elect to issue if book building
is available. Third, we assume that for the largest or oldest two quintiles of the population ofprospective issuers, unobservable aspects of firm quality are sufficiently unimportant that all firmsthat would issue by book building also would do so by auctioning.
In Panel (a), we report estimates of the numbers of auction-regime non-issuers on the basis offirm age. We derive the estimates first on the basis of the entire book-building sample, and second

when book building is used. The coefficient is marginally significant (at the 10 percent level), and indicates that bookbuilding accounts for an increase of about 12 percentage points in the probability of an issue being venture capital backed.

21

on the pre-1999 subsample. When the subsample is used, we scale the results to estimate the numberof non-issuers during the full auction sample period. Estimates in Panel (b) are based on the same
methodology, but use data on number of employees. Our estimates of the number of non-issuers
during the auction regime range from 102 to 145. Given that 163 auction IPOs occurred, theestimates imply that a substantial fraction of potential issuers did not issue.37 All ranked differences
between actual and expected numbers are highly significant.
Consistent with book building improving pricing accuracy, we find evidence that someovervalued firms may have rushed to complete offerings before introduction of book building. For
this to be a rational tactic, auction bidders must not fully understand how book building would affectpricing accuracy. Though the numbers are too small for rigorous testing, the amount of IPO activity
in September 1997, just before the regime change, was unusually high. In 1997, there were 25
offerings in September, compared to 12 in October. In 1996, both months had 16. For August and
September combined, 1996 and 1997 are similar at 30 and 33. The pricing evidence also suggeststhat the firms trying to complete offerings before introduction of book building tended to be
overvalued. Of the 24 overpriced auction IPOs in our sample, 12 occurred in September 1997, 48.0
percent of the September offerings.

Except for September 1997, only 4.1 percent of auction

offerings were overpriced. Furthermore, average overpricing for the 12 in September 1997 was 22.9
percent, compared to 7.5 percent for the other 12.38
The underwriter’s role and the structure of issue costs: The agreement, during Japan’s
auction regime, to fix fees as a percent of proceeds helps explain why the auction method could
discourage or impede potential issuers. If some of the costs of marketing the issue are fixed, then the
low percentage fee could prevent small firms from offering.
37

Although Table 4 implies that the activity level was higher under book building than would have been expected underauction, the overall rate of IPO activity was lower during book building. Practitioners in Japan attribute the decline to theworsening overall level of stock market prices.
38
The minimum successful bids of overpriced IPOs in September generally were at the minimum permissible bids. The
ratios of shares-bid-for to shares-offered also were low. Public offer tranche discounts from the weighted average
successful bid were small and sometimes constrained by the minimum permissible bid.

22

If the underwriter’s pricing role in auction IPOs is different than in book building, thedifferences should affect the structure of issue costs.

First, if the underwriter performs more

extensive due diligence, pre-marketing, and value certification for book-built than for auctioned IPOs,
then firm characteristics should affect fees of book-built IPOs to a greater extent.

Second,underwriters with established reputations should be more able to charge higher fees for book-built
IPOs.39 Third, corresponding to the inability of such underwriters to charge higher fees for auction
IPOs, they may be able to reduce their costs by underpricing more. Because the auction method
limits ability to underprice, it is unclear whether systematic underpricing in relation to underwriter
reputation will be more or less under book building. Fourth, if there are scale economies ofunderwriting, then percentage fees or underpricing should decrease with increases in issue size. Fifth,
if investors use the offer price along with information on the firm, the issue, and the underwriter toinfer aftermarket value in book-built IPOs, then these factors should affect underpricing. Finally,fees and underpricing should be substitute components of total issue cost.
In Table 5, we examine the determinants of underwriter fees and underpricing.40 We specify
the fee as a percent of offer price, so the measure is not affected by underpricing. The fee models are
fully interacted for differences between auctioning and book building, and include variables related
to issuer track record, issue size, and underwriter market share. In the underpricing models, westandardize by first aftermarket price. Except for runup over the 40 days before the IPO, theunderpricing models also are fully interacted with regime. We restrict the runup coefficient to be thesame in both regimes because limited cross-sectional variation during the auction regime precludes

39

Underwriters with larger market shares may earn superior returns on effort for several reasons: First, they may havesuperior ability to place issues. Second, they may be more credible as certifiers. Third, underwriters with low shares may
sacrifice short-run profitability to develop reputations. These factors all imply that underwriters with larger shares are able
to earn higher fees. Additionally, Carter and Manaster (1990) indicate that US underwriter reputation is positively related
to issuer quality. Such a relationship could lead to a negative association between underpricing and underwriter share.
Carter, Dark, and Singh (1998) find that IPOs managed by more prestigious underwriters are less underpriced.
40
The empirical models in Tables 5 and 6 are parsimonious, while allowing for testing of various hypothesized
relationships. Adding more indicators of issuer age or track record does not materially affect the models’ overall
explanatory power and does not materially alter the findings in the remainder of the paper.

23

an accurate estimate based solely on auction data. For underpricing, we test for differences related to
track record, issue size, and underwriter market share. We also include fees standardized by offer
price. Model structures are consistent with a paradigm where fee is determined first, and intended
underpricing is established second, based on fee. By including runup, we allow unanticipatedchanges in the market to affect underpricing.
Results conform to expectations. Except for the intercept of 3.5 percent, the models do not
explain auction fees. Conversely, for book building, issuer track record variables and underwritermarket share both are significant. While we anticipated that, for book building, firm age would be
negatively related to fee, the positive relationship is more than offset by a significant reduction inunderpricing. Older firms pay more, but, in return, are much less underpriced. We find a similar
pattern for issue size, where non-significant fee coefficients for book-built IPOs are paired withnegative underpricing coefficients.
With respect to underwriter market share (our measure of reputation), for auction IPOs there
is no significant relation to fee, but the relation to underpricing is positive. Underwriters with highmarket shares underprice more. For book-built IPOs, these results reverse. The relation between
market share and fee is positive and significant, whereas the coefficient on market share in theunderpricing regressions reverses the positive coefficient for auction IPOs.
The reversal is evidence that fees and underpricing are substitute components of total issuecost. Fee is not significant in explaining underpricing, but the lack of a relationship is consistent with
substitution. In the underpricing models, fee is standardized by offer price. If it were standardized
by aftermarket price, the substitution effect would be almost deterministic. All else the same,
increased underpricing reduces the fee as a percent of aftermarket price. For the two not to function
as substitutes, underwriters would need to charge higher percentage fees when they anticipated24

higher underpricing. As, based on Table 5, they do not appear to do so, higher underpricing reducesfee, when fee is measured against aftermarket price.41
Total issue cost and issue size: Assuming that all firms issue and try to maximize net
proceeds per share, and that aftermarket prices are unbiased measures of value, why would an issuer
select book building if it leads to higher total issue cost? Underinvestment implies that the shift is a
response to adverse selection. Book building prevents low-quality firms from pooling with highquality firms. Also, reliance on book building may indicate that firms are not concerned solely withexpected net proceeds.42
To compare auctioning and book building at the firm level, we model total issue cost by
auctioning and by book building. We use the model to estimate and compare the hypothetical total
issue cost that each issuer would have realized had it issued in the other regime.
The customary approach of comparing expected cost under different issuance methods iswith a simultaneous equation system that controls for choice selectivity. However, in this case, selfselection does not bias our estimates of expected total issue cost. Issuers during the auction regime
could not select book building and issuers during the book-building regime did not select auction.
The only caveat is that in the transition month between regimes, a small number of firms appear tohave implicitly chosen by timing their offerings.43
However, choice of method given regime leaves open the possibility that issuers may prefer
one regime over the other, and the question of which regime is expected to maximize the aggregate
value of investment opportunities after all issue costs. The underinvestment problem implies that,during the auction regime, there also may be a self-selection censoring effect with respect to the41

The coefficient on underwriter fee, when it is standardized by aftermarket price, is negative and highly significant.
Habib and Ljungqvist (2001) make a similar argument for substitutability of fees and underpricing.
42
Sherman (2002), for example, models the difference between book building and auctioning under assumptions that canyield equal expected proceeds between approaches, but where book building reduces the risk of undersubscription and canincrease expected offer size.
43
The two auctioned issues during the first month of book building appear to be carry-overs from auction processes thatbegan before book building was permitted.

25

decision to go public. While this is a more serious problem, no existing method enables us to control
formally for censoring when the population of non-issuers is unknown. Instead, we recognize thedirection of the bias and factor it into our interpretation of results.
While the IPO pricing regime is expected to affect issue cost, prospective issuers can respondby adjusting issue size. The data in Table 3 demonstrate that auction IPOs are larger in absoluteterms, but smaller as a fraction of outstanding shares. This raises the prospect that total issue costand issue size are determined simultaneously. We tested this by estimating a simultaneous systemfor percent issue cost and absolute issue size. However, the exogenous variable coefficients were notsignificantly or materially different from ordinary least squares results and the endogenous variable
coefficients were not significant.

The findings suggest that the pricing regimes affect thecharacteristics of issuers and the sizes of offerings, but that firms do not select issue size to affectissue cost. Correspondingly, after controlling for firm characteristics, issue cost as a percent ofaftermarket price bears little relation to issue size.
In the first two numerical columns of Table 6, we report models of total issue cost. We selectvariables for inclusion in the models based on the literature, as discussed above. As in Table 5, we
restrict the coefficient on runup in the JASDAQ Index to be the same over the entire period. But forthis exception, the models are fully interacted with the regime indicator variable.
Results are consistent with earlier discussion. Our interpretations, in some cases, draw on theWald tests of restrictions reported at the foot of the table. Issue cost is significantly greater after
periods of runup, suggesting that offer prices do not adjust fully to changes in the market. Issuer age,sales revenue, and equity book value are not significantly related to the total cost of auctioned IPOs.
The incremental coefficients of these variables for book-built IPOs are negative and generally
significant. Results indicate that, the percentage cost of book building is less for large issuers withestablished track records.

26

Expanding on discussion of Table 5, during the auction regime, underwriters with larger
market shares are associated with higher total issue cost, but the relation substantially disappears inthe book-building regime. For high-market-share underwriters, the lower underpricing in Table 5
offsets higher fees. The empirical relationship of total issue cost to venture capital backing in Table
6 suggests a certification or monitoring role for venture capital.44 Particularly for the three-year
subsample, book-built IPOs with venture capital backing have lower issue cost.
In the last two columns of Table 6, we report findings for issue size. Because issue size is afunction of price and firms may attempt to issue more shares after runups, we include a measure ofrecent market runup. We assume that the decision to offer is made about 40 market days before theoffering and measure runup over 60 market days prior to that. In addition to measures of firm trackrecord and underwriter market share, we allow for the possibility that the market is more receptive toan offering that represents a small fraction of outstanding shares.
The Table 6 results for issue size are a contrast with those for total cost. First, the interacted
intercept coefficient for book-built IPOs nullifies the positive intercept for auctioned IPOs. Second,firm track record measures are positively and significantly related to the issue size of auctioned IPOs.
In most cases, incremental coefficients for book-built IPOs are not significant. The exceptions, in thethree-year subsample, are that the auction coefficient on sales revenue is reversed and the bookbuilding coefficient on equity book value is significantly positive. Results are related to skewness ofthe offering distribution in the book-building subsample. More than in other periods, the data include
many small IPOs and a few large ones. Pre-offer firm value is positively related to issue size of
44

Megginson and Weiss (1991) argue that venture capitalists provide certification. Barry, Muscarella, Peavy, andVetsuypens (1990) suggest that monitoring is the source of value creation. Packer (1996) finds that, in Japan, either bankshareholding or investment through a venture capital subsidiary is associated with lower underpricing. Kutsuna, Cowling,and Westhead (2000) focus on changes in venture capital holdings after IPOs of Japanese firms. They find that companies
in which venture capital firms sell equity stakes after flotation under-perform companies in which venture capitalists do
not invest or where they maintain equity stakes. Kutsuna, Okamura, and Cowling (2002) find that venture capitalownership is significantly related to post-IPO operating performance. Lin and Smith (1998) find that venture capitalbacked firms go public with less well-established track records than other issuers. Thus, venture capital-backing could be
associated with higher levels of underpricing. Loughran and Ritter (2003) find that venture capital-backed offerings areassociated with higher initial returns for both US and Japanese firms.

27auctioned IPOs, as expected. The incremental coefficients suggest that book building also enables
issuers to increase offer size.45
Economic significance of the regime change: To assess the potential for book building toresult in overinvestment in information, we use the Table 6 models to estimate expected total issue
cost of each issuer for the IPO pricing method actually used and for the same offer by the alternative
method. As we cannot correct for bias due to underinvestment, all results in Tables 7 through 9 arebiased in favor of auction.
Differences in equal-weighted average total issue cost: Table 7 contains a summary of theequal-weighted results. The results are similar in each of the three sets of comparisons in the table.
We focus discussion on the estimates derived when the model for the three-year subsample is used toestimate expected total issue cost for that subsample. For IPOs priced by auction, we estimate thatmean and median expected total issue cost would have been higher under book building. Ignoring
bias due to underinvestment, the mean cost advantage of auctioning is 5.68 percent of firstaftermarket price. For IPOs priced by book building, the mean cost advantage of auctioning is 6.29
percent. The estimates are similar when the three-year and five-year models are used to price IPOs in
the full sample.
Based on the classifications reported at the bottom of Table 7, pricing by auction is projected
to result in lower total cost for 226 of the 274 IPOs in the subsample, or 82.5 percent. Ignoring bias
due to underinvestment, both auctioned and book-built issues include more IPOs that are projected tohave lower total cost by auction.

45

Consistent with the incentive of high-quality firms to mitigate uncertainty, if investment can be staged, a firm can seekminimum funding initially and wait for undervaluation to be resolved. Grinblatt and Huang (1989) model underpricing asa quality signal, where quality depends on both expected cash flows and uncertainty. High-quality firms issue initially at
low prices and use seasoned offerings to complete the capital-raising effort. Low-quality firms that attempt to imitate
high-quality firms run the risk of being discovered before the seasoned offering can be completed. Welch (1989), in a
related model, explores the conditions under which high quality firms signal by underpricing and limiting IPO size. Allenand Faulhaber (1987) develop a similar model. These signaling equilibria imply that seasoned offerings shortly after IPOs
are more likely in the auction regime. Although 42 IPOs in our sample were followed by seasoned offerings within one
year, we found no significant differences related to regime.

28

While, on a cost basis, most issuers in our sample appear to fare better with auction, theapparent cost advantage must be weighed against the unobservable opportunity losses fromunderinvestment. If underinvestment is negligible, then the evidence in the table is an unbiased
estimate of the cost advantage of auction, suggesting that pricing by auctioning reduces mean total
issue cost in our sample by an average of about 6.0 percent of first aftermarket price. Taking
underinvestment into account, this is an upper bound estimate of the advantage of auctioning.
Apparent beneficiaries of auctioning and book building: In Table 8, we classify issuers asapparent beneficiaries of auctioning or book building.
estimated from the three-year subsample.

Classifications are based on the model

Because of small sample sizes in some groups, weconstruct the table based the full sample. Results based on the full sample model and on only the
subsample data are similar. The top half of the table pertains to auction IPOs and compares issuers
expected to achieve apparently lower cost using auctions against issuers expected to achieve lower
cost using book building. Based on the statistical estimates, firms that apparently benefit fromauctioning are younger and smaller than firms that benefit from book building. However, auction
beneficiaries are less likely to be venture capital backed. While average issue size of auction
beneficiaries is smaller, relative issue size is larger. The lower portion of the table provides the same
comparisons for book-built IPOs and yields similar results.
Comparisons of the characteristics of apparent auction beneficiaries support our concern that
underinvestment biases downward the estimates of expected total issue cost by auction. While therelative cost evidence suggests that younger and smaller issuers can achieve lower cost with auctions,the smallest and youngest firms are, for the most part, absent as issuers during the auction regime. If
their absence is due to underinvestment, then the estimates of auction-method total cost are
negatively biased, particularly for the small and young issuers. Our conclusion is that the auction
method functions as a capital market barrier for small, young, and risky issuers.

29

Differences in aggregate total issue cost: Because the cost advantage of book building isgreatest for large issuers, comparisons of equal-weighted-average percentage cost advantages do notreveal whether, in aggregate, auctioning or book building is lower cost. To address this, in the upper
portion of Table 9 we report absolute measures of total cost in the same manner as the percentage
comparisons in Table 7. All estimates in Table 9 are based on the issue cost model from the threeyear subsample. Results for the full sample model are similar. Based on the issues that did occur
during the study period, the aggregate total issue cost of book building and apparent aggregate total
issue cost of auctioning are similar. When we apply the model just to the subsample, book building
appears to be slightly less costly. However, when we apply the model to the full sample, auctioning
appears to be slightly less costly.
To illustrate, focusing on the subsample, we estimate that the expected aggregate issue costof the auction method is 69.4 billion yen for IPOs actually priced by auction and 25.7 billion yen for
those actually priced by book building. The expected total is, thus, 95.0 billion yen, or 346.9 million
yen per IPO. The comparable aggregate total cost estimate for book building is 69.4 billion yen, or
253.4 million yen per IPO. Thus, we estimate that the aggregate additional cost to JASDAQ issuersof relying on the auction method from 1996 through September 1997 was 25.6 billion yen. Again,
this does not reflect the negative value of opportunity losses from underinvestment in the auction
regime. Applying the same analysis to the entire sample, we estimate that reliance on book building
from late 1997 through 1999 cost issuers an aggregate of 26.4 billion yen. This estimate is subject tothe same bias in favor of auctioning.
In the lower portion of Table 9, we compute issue-size-weighted average percentage costs
and cost differentials. For the three-year subsample, we estimate that the overall cost disadvantageof the auction method is 3.27 percent. This compares to an apparent advantage of about 6.0 percent
on an equal-weighted basis. For the full sample, auctioning appears to have a cost advantage of 1.43
percent on an issue-size-weighted average basis.
30

However, this estimate is based partly onextrapolation of the three-year model to predict issue costs for the entire five-year sample.
Furthermore, none of the cost estimates of auctioning in Table 9 accounts for the reduction in total
issue cost by auctioning that appears to have resulted from the fee-fixing agreement. Setting fees
aside, the Table 9 results suggest that aggregate underpricing would have been lower under bookbuilding on the basis of either the full sample or the subsample.
Though, narrowly construed, our cost evidence is neutral, the estimates fully reflect costs of
information production but do not correct for bias due to underinvestment. Hence, the arguments forbook building turn on its ability (which our evidence supports) to reduce underinvestment and on theother benefits of more accurate pricing. Though small issuers might benefit from restricting allissuers to use auction, the aggregate total issue cost comparisons, in conjunction with the otherbenefits of book building, are more than offsetting.
VI.

Discussion
Japan’s introduction of book building in 1997, as an alternative to its existing auction IPO

method, is a market experiment that we use to examine the choice of regime as a policy question.
We find evidence that Japan’s auction method resulted in adverse selection. Under the auction
method, high-quality issuers had limited ability to distinguish themselves from low-quality issuers.
As a result, it appears that some high-quality firms elected not to issue.
When book building was introduced as an alternative, all issuers quickly switched to bookbuilding. By placing the underwriter in a more central role in determining IPO prices, book building
addresses the underinvestment problem. However, book building also can lead to overinvestment in
information about the relative values of issuers. When both offering methods are available, and firms
differ in unobservable quality, book building can drive out auctioning even if book building increases
aggregate total issue cost and does not reduce aggregate underinvestment by enough to offset thehigher cost. Therefore, the policy decision to permit book building cannot be based only on therevealed preferences of issuers. Instead, the impact on aggregate total issue cost, the magnitude of31

the underinvestment problem, and the benefits of more accurate pricing are all relevant to the regime
choice.
Using a sample of IPOs by Japanese firms, we document that average total issue cost,measured as a percent of aftermarket price, was significantly higher in the book-building regime thanin the earlier auction regime.

This result, however, does not compare the expected costs ofauctioning and book building for particular firms. It also does not account for the possibility that, if
only auctioning available, some high-quality firms may underinvest. Based on models of expected
total issue cost, we find that small and risky firms incur higher costs with book building but larger
and better-established issuers realize cost savings.
To test for overinvestment in information, we estimate and compare, for each IPO in thesample, expected total issue cost by auctioning and by book building. Weighting the observations
equally, the estimates indicate that average total issue costs, if all IPOs in our sample were by auction,is less than if all were by book building. However, when results are weighted by issue size, theestimated aggregate costs of auctioning and book building are similar. This outcome favors bookbuilding for two reasons. First, auction-method estimates do not reflect opportunity costs related tounderinvestment. Second, issue cost estimates ignore other benefits of the more-accurate pricing thatbook building affords.
The findings raise several policy issues: Given that, in Japan, the expected aggregate issue
cost of book building is similar to that of auctioning and that book building reduces underinvestment
and results in more accurate pricing, is it possible to generalize that equity capital markets areenhanced by permitting book building? Is there still a role for Japan-style auctions, the new auction
experiments being tried in the US, or other methods such as best efforts and competitive bidding that
limit information production? Our evidence suggests that the answer depends partly on the mix ofpotential issuers. Offering regimes, such as Japan’s book-building regime, that promote information
production, appear to be better in markets where desired issue sizes are large and where small issuers
32are heterogeneous, hard to value, and prone to underinvest if they cannot be valued accurately.
Offering regimes, such as Japan’s auction regime, that inhibit information production by issuers andinvestors, may be better in markets where desired issue sizes are small but prospective issuers areeasy to value accurately with public information.

[2003.5.21 650]

33

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37

-200%

38

Listing Date (YYYYMMDD)
19991216

19991111

19991013

19990914

19990708

19990414

19981211

19981117

19980917

19980730

19980605

19971224

19971107

1997100719970917

19970904

19970801

19970710

19970418

19970207

19961212

1996111919961018

19960919

19960905

19960802

19960628

19960423

19960223

19951214

19951115

19951024

19951006

19950919

19950822

19950725

19950620

19950427

19950403

19950303

19950124

Initial Returns of 484 JASDAQ IPOs

1000%
(Percent of Public Offer Price)

800%

AuctionBook Building

600%

400%

200%

0%

39
Date

07/04/2000

05/04/2000

03/04/2000

01/04/2000

11/04/1999

09/04/1999

07/04/1999

05/04/1999

03/04/1999

01/04/1999

11/04/1998

09/04/1998

07/04/1998

05/04/1998

03/04/1998

01/04/1998

11/04/1997

09/04/1997

07/04/1997

05/04/1997

03/04/1997

01/04/1997

11/04/1996

09/04/1996

07/04/1996

05/04/1996

03/04/1996

100

01/04/1996

120

11/04/1995

09/04/1995

07/04/1995

05/04/1995

03/04/1995

01/04/1995

with Auction and Book Building Sample Periods

JASDAQ Stock Index

140

1995 Auction

Post-1995 Auction

Pre-1999 Book Building

1999 Book Building

80

2000

60

40

20

0

Table 1
Descriptive Statistics on Tranche Size, Underpricing, and Discounting for 321 Auction Method JASDAQ IPOs
January 1995 - September 1997
Japan required use of a hybrid auction method during this period. At least 50% of the Total Issue (the "Auction Tranche") was required to be offered bydiscriminatory auction. The minimum acceptable bid (the "Minimum Price") was computed by application of a formula and was stated in the prospectus forthe auction. Remaining shares (the "Public Offer Tranche") were sold in a firm commitment offering, usually at a discounted price (the "Offer Price") from theWeighted Average Successful Bid Price.

Mean

Std. Dev.

Median

50.6%

1.7%

50.0%

50.0%

60.0%

81.3% (261 obs.) have a 50% auction
tranche.

4.46

2.61

3.90

0.80

20.80

0.9% (3 obs.) have ratios less than 1.0.

146.4%

64.6%

121.1%

100.0%

616.2%

12.5% (40 obs.) have min. bid equal tomin. price.

153.3%

68.3%

121.7%

100.0%

644.3%

0.3% (1 obs.) have wtd. Avg. bid equal
to min. price.

Offer Price Discounting
Min. Successful Bid to Wtd. Avg. Successful Bid

95.7%

2.3%

96.1%

86.7%

100.0%

0.3% (1 obs.) have min. successful bid
equal to wtd. avg. successful bid.

Offer Price to Weighted Average Successful Bid

92.9%

4.4%

93.4%

81.9%

100.0%

0.3% (1 obs.) have offer price equal towtd. avg. successful bid.

Offer Price to Min. Successful Bid

97.1%

4.3%

99.3%

85.3%

107.8%

40.1% (129 obs.) have offer price equal
to min. successful bid. 8.4% (27 obs.)
have offer price above min. successfulbid.

Size of Auction Tranche
Auction Tranche to Total Issue
Shares Bid For to Shares Offered by Auction
Minimum Bid Underpricing
Min. Successful Bid to Min. Price
Wtd. Avg. Successful Bid to Min. Price

40

Minimum Maximum

Other Comments

Table 2
Underwriting Fees, Initial Returns, and Total Issue Cost of JASDAQ IPOs
January 1995 - December 1999 and Selected Subperiods

Underwriting Fee, Initial Return, and Total Issue Cost (Fee + Initial Return) for entire IPO sample, all Auction IPOs, all Book
Building IPOs, and selected subsample: In Panel (a), costs are expressed as percentages of gross proceeds. In Panel (b),costs are expressed as percentages of the first aftermarket value. Mean t-values are based on the hypothesis that sample
means are equal between the Auction and Book Building samples and between the Auction and Book Building subsamples.
The t tests are constructed assuming unequal variances. Variance P-values are based on F tests of the hypothesis of equalvariances between samples or subsamples.
Panel (a)Underwriting Fees/Offer Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

Obs.

Mean

Median

484
321
163
185
90

4.07%
3.26%
5.66%
3.30%
5.52%

3.36%
3.24%
5.77%
3.28%
5.51%

1.18%
15.00%
0.49%
17.00%
0.50%

0.85
0.53
0.22
0.21
0.46

Initial Return/Offer Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

484
321
163
185
90

28.57%
7.12%
70.81%
5.93%
19.45%

5.71%
3.77%
20.00%
3.67%
9.19%

84.64%
14.80%
134.97%15.19%
40.84%

5.77
1.71
3.31
1.44
3.65

Total Cost/Offer Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

484
321
163
185
90

32.64%
10.38%
76.47%
9.23%
24.98%

9.27%
7.03%
26.00%
7.00%
14.92%

85.06%
14.77%
135.01%15.15%
40.87%

5.73
1.72
3.30
1.44
3.64

Obs.

Mean

MedianStd. Dev. Skewness

484
321
163
185
90

3.50%
3.10%
4.30%
3.18%
4.95%

3.23%
3.13%
4.67%
3.17%
4.90%

1.15%
0.45%
1.61%
50.00%
1.20%

1.21
0.55
-0.17
0.66
0.47

Initial Return/Aftermarket Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

484
321
163
185
90

11.36%
5.07%
23.75%
3.82%
10.35%

5.40%
3.64%
16.67%
3.54%
8.41%

21.02%
11.92%
28.35%
13.00%
20.66%

1.14
-0.22
0.27
-0.54
-0.34

Total Cost/Aftermarket Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

484
321
163
185
90

14.86%
8.17%
28.04%
7.00%
15.30%

8.75%
6.78%
21.67%
6.75%
13.64%

20.42%
11.49%
26.80%
12.53%
19.56%

1.16
-0.20
0.26
-0.53
-0.35

Panel (b)Underwriting Fees/Aftermarket Price
Entire Sample
All Auction
All Book Building
Auction post-1995
Book Building pre-1999

41

Std. Dev. Skewness

Meant-value

Variance
P-value

60.96

0.0%

41.53

0.0%

6.01

0.0%

3.04

0.0%

6.23

0.0%

3.67

0.0%

Mean
t-value

Variance
P-value

9.34

0.0%

13.39

0.0%

8.01

0.0%

2.74

0.0%

9.05

0.0%

3.67

0.0%

Table 3
Descriptive Statistics for Sample of 484 JASDAQ IPOs
January 1995 - December 1999 and Selected Subperiods

Data are for IPOs during the entire period and various subperiods. Significance tests of differences in means (t-values) and medians (MannWhitney U test Z-values) are reported for the following groups: (1) Auction IPOs versus Book Building IPOs, (2) Auction IPOs after 1995
versus Book Building IPOs before 1999, and (3) Book Building IPOs before 1999, versus during 1999. Calendar year 1999 was a period of
rapid market runup and high market volatility. Panel (a) contains data for the JASDAQ market. Panel (b) contains company-specific data
related to issuer size and track record. Panel (c) contains data on the underwriter and on venture capitalist involvement. Panel (d)contains data on absolute and relative offer size. Company data are from the IPO prospectus and proxy statements. Asterisks indicate
significance at 10 percent, 5 percent and 1 percent levels in two-tail tests.

EntireAll
All Book Post-1995
Sample Auction Building
Auction
(1)
(2)
(3)
(4)
Panel (a)Capital Market Uncertainty
JASDAQ Market Runup (day -40 to day -1)
Mean-0.23%-3.76%
6.72% -5.71%
Median-2.40%-4.89%
5.46% -6.50%

Pre-1999
Book
Building(5)

1999 Book
Building(6)-3.99%-4.77%

19.92%
19.76%

Test(2 = 3)Test(4 = 5)Test(5 = 6)t-value
Z-value

7.81***
6.91***

1.36
0.59

14.55***
9.65***

JASDAQ Market Runup (day -100 to day -40)
Mean
2.59%
-0.99%
9.64%
Median-0.29%-1.86%
1.42%-0.30%
0.81%-9.98%-8.72%

33.81%
36.63%

t-value
Z-value

5.18***
3.07***

8.29***
7.02***

21.74***
10.92***

Panel (b)Issuer Size and Track Record
Age of Issuing Firm (years)
Mean
28.26
30.00
24.84
Median
26.60
29.90
23.30

28.26
26.35

24.49
23.71

25.26
23.04

t-value
Z-value

3.94***
4.08***

2.26**
2.24**

0.35
0.13

Number of Employees
Mean
434.44
Median288.00464.95318.00374.34236.00456.18314.00369.89218.00379.84241.00t-value
Z-value

1.97**
3.42***

1.61
2.25**

0.13
0.65

Equity Book Value (millions of Yen)
Mean
832.43953.19Median563.50607.00594.62448.00970.63574.50622.13497.00560.70384.00t-value
Z-value

3.68***
5.43***

2.26**
2.08**

0.75
1.68*

Sales Revenue (millions of Yen)
Mean
17,687
18,607
Median11,698
12,176

15,873
10,245

18,37910,965

16,882
10,495

14,63010,031t-value
Z-value

1.61
1.80*

0.59
0.32

0.97
0.34

Premoney Value at Issue Price (millions of Yen)
Mean
18,482
18,461
18,526Median
8,863
9,774
5,786

21,451
9,687

13,495
3,671

24,7289,374

t-value
Z-value

0.01
4.99***

1.09
5.81***

1.31
4.51***

Panel (c)Underwriter and Venture Capitalist Certification or Market Power
Underwriter Market Share
Mean
20.34%
19.09%
22.79% 19.30%
22.21%
23.51%Median17.40%
17.40%
25.80% 17.40%
25.80%
25.80%

t-value
Z-value

3.63***
6.17***

2.03**
3.92***

0.80
0.39

Venture Capital Backing (binary)Mean
58.47%
50.16%Median100.00% 100.00%

74.85%
100.00%52.72%
100.00%70.00%
100.00%80.82%
100.00%t-value
Z-value

5.60***
5.20***

2.83***
2.72***

1.61
1.58

Panel (d)Offer Size
Gross Proceeds of Offering (millions of Yen)Mean
2,853.69 2,841.67
2,877.35
Median1,656.50 1,867.00
1,254.00

3,006.23
1,943.00

2,025.48
746.25

3,927.60
2,040.00

t-value
Z-value

0.08
4.63***

1.78*
6.03***

2.25**
4.81***New Shares/Shares Outstanding
Mean
19.36%
18.60%Median18.40%
18.10%

18.82%
18.06%

20.58%
19.09%

21.18%
20.16%

t-value
Z-value

4.65***
4.70***

2.67***
2.53**

0.68
1.09

20.85%
19.79%

42

Table 4

Estimates of Number of Non-Issuers During Auction Period
January 1995 - December 1999 Sample Period and January 1996 - December 1998 Subperiod
Estimates are derived based on the assumptions that (1) distributions of issuer firm ages or numbers of employees during the auction regime would have been the same as theactual distributions during the book building regime, and (2) that issue decisions of firms in the highest two age and employee quintiles during the auction regime are notaffected by the requirement to use the auction method to price the offering. Estimates in Panel (a) are based on firm age for the entire period and for the period from 1996
through 1998. Estimates in Panel (b) are based on numbers of employees. The "Actual Minus Expected" column is an estimate of the reduction in IPOs due to the auction
requirement. Estimates in the "Implied for Full Sample" column are constructed by scaling up the actual number of auction IPOs from 184 to 321, and are included to facilitatecomparisons of estimates based on the full period and the 1996 through 1998 period. Ranked differences between actual and expected IPO levels are highly significant in allcases.

Panel (a) Projections Based on Distributions of Firm Age
Using Data for the Entire Sample Period
Age Quintiles of Book
Building IPOs
0.00 to 12.09 years
12.10 to 19.06 years
19.07 to 26.06 years
26.07 to 36.11 years
Over 36.11 years
TotalsUsing Data from 1996 though 1998

Book
Building
IPOs
33
32
33
32
33

ActualAuction
IPOs
24
51
60
77
109

ExpectedAuction
IPOs
94
92
94
92
94

ActualMinus
Expected
-70
-41
-34
-15
15

163

321

466

-145

Age Quintiles of Book
Building IPOs
0.00 to 13.05 years
13.06 to 18.40 years
18.40 to 25.40 years
25.41 to 35.10 years
Over 35.10 years
TotalsBook
Building
IPOs
18
18
18
18
18

ActualAuction
IPOs
26
22
39
41
56

ExpectedAuction
IPOs
49
49
49
49
49

ActualMinus
Expected
-23
-27
-10
-8
8

Impliedfor Full
Sample
-39
-46
-17
-13
13

90

184

243

-59

-102

Panel (b) Projections Based on Number of Employees
Using Data for the Entire Sample Period
Employment Quintilesof Book Building IPOs
0 to 130 employees
131 to 189 employees
190 to 281 employees
282 to 494 employees
Over 494 employees
TotalsUsing Data from 1996 though 1998

Book
Building
IPOs
33
32
33
32
33

ActualAuction
IPOs
30
54
55
93
89

ExpectedAuction
IPOs
92
90
92
90
92

ActualMinus
Expected
-62
-36
-37
3
-3

163

321

456

-135

Employment Quintilesof Book Building IPOs
0 to 120 employees
121 to 169 employees
170 to 273 employees
274 to 618 employees
Over 618 employees
Totals43

Book
Building
IPOs
18
18
18
18
18

ActualAuction
IPOs
20
26
34
72
32

ExpectedAuction
IPOs
52
52
52
52
52

ActualMinus
Expected
-32
-26
-18
20
-20

Impliedfor Full
Sample
-56
-45
-31
35
-35

90

184

260

-76

-133

Table 5

Regression Results for Underwriter Fees and Underpricing
Full 1995 - 1999 Sample and 1996 - 1998 Subsample
Underwriter fee is expressed as a percent of issue price. Underpricing is expressed as a percent of firstaftermarket price. Full sample estimates are based on 484 JASDAQ IPOs. Subsample estimates are based on
274 IPOs. Interactions with Book Building are designated as "BB*variablename." Coefficient t-values are initalics. Asterisks indicate significance at 10 percent, 5 percent and 1 percent levels in two-tail tests.

Underwriter Fees/
Issue Price(percent)
Independent Variables
Intercept

Underpricing/
Aftermarket Price(percent)

Full Sample

Subsample

Full Sample

Subsample

3.45268
59.60***

3.50072
45.26***

6.24608
0.68

12.92362
1.32

0.82729
12.96***

0.84682
9.23***-0.04084
0.57-0.04980
0.64

Market Runup day -40 to day -1 (percent)Age of Issuing Firm (years)-0.00154
1.13-0.00088
0.46

Sales Revenue (billions)-0.00026
0.24-0.00030
0.22

Issue Size (billions)-0.00661
1.16-0.00702
0.96-0.271001.22-0.08940
0.44

Underwriter Market Share (percent)

0.000190.12-0.00052
0.25

0.17027
1.97**

0.12960
1.44

BB*Intercept

1.98924
21.32***

1.8840714.86***

28.75568
4.09***

26.76458
3.66***

BB*Age of Issuing Firm (years)

0.00493
2.18**

0.003811.14-0.54038
4.64***-0.53260
4.01***BB*Sales Revenue (billions)-0.00639
2.99***-0.00511
1.85*

BB*Issue Size (billions)

0.00383
0.48

0.00770
0.62-0.55500
1.63-2.32800
5.57***BB*Underwriter Market Share (percent)

0.01069
3.89***

0.00763
2.14***-0.22417
1.49-0.074770.49

0.20159
0.08-1.47981
0.57

0.43

0.38

Underwriter Fee (percent)
Adj R^2

0.93

44

0.92

Table 6
Regression Results for Total Cost and Issue Size
Full 1995 - 1999 Sample and 1996 - 1998 Subsample
Full sample estimates are based on 484 JASDAQ IPOs. Subsample results are based on 274 IPOs. Interactions with book building aredesignated as "BB*variablename." Coefficient t-values are in italics. Asterisks indicate significance at 10 percent, 5 percent and 1 percent
levels in two-tail tests. Wald tests of hypotheses that cumulative coefficients for book building samples are significantly different from zeroand of hypotheses that book building models are significantly different from auction period models.
Total Cost/
Aftermarket Price(percent)
Independent Variables

Issue Size(million Yen)

Coef.

Full Sample

Subsample

Full Sample

Subsample

Intercept

c1

8.058
2.52**

10.8442.90***

1643.72
4.00***

2170.85
4.11***

Market Runup -40 to -1 (percent)

c2

0.734
12.48***

0.821
8.94***

Market Runup -100 to -40 (percent)

c3

16.43
2.86***

16.19
1.15

Age of Issuing Firm (years)c4-0.0150.22-0.0470.60-33.11
3.48***-45.83
3.59***

Sales Revenue (billions)

c5

0.012
0.26

0.007
0.15

37.48
4.96***

42.43
4.44***

Equity Book Value (billions)c6-0.6411.04-0.2560.44

318.553.04***

179.98
1.61*

Value of Outstanding Shares (billions)

c7

4.03
12.46***

3.87
10.74***

Underwriter Market Share (percent)

c8

0.151
1.89*

0.122
1.37

24.19
2.15**

18.12
1.25

Venture Capital Backing (binary)

c9

1.647
0.94

-0.0890.04

BB*Intercept

c10

33.041
6.22***

27.236
4.37***-1544.36
2.28**-2001.94
2.14**

BB*Age of Issuing Firm (years)c11-0.376
3.37***-0.313
2.27**

5.09
0.31

18.26
0.79

BB*Sales Revenue (billions)c12-0.4083.85***-0.3603.28***

2.38
0.15-41.03
1.93*

BB*Equity Book Value (billions)c13-3.506
1.24-1.1640.33

156.930.38

1179.932.05**

BB*Value of Outstanding Shares (billions)

c14

3.68
7.46***

3.78
5.06***BB*Underwriter Market Share (percent)c15-0.1501.08-0.032
0.21

13.91
0.72

14.57
0.59

BB*Venture Capital Backing (binary)c16-1.0470.32-8.237
2.25**

0.48

0.36

0.77

0.79

Adj R2
Wald Test Results (F test P-values)
c4+c11=0
c5+c12=0
c6+c13=0
c7+c14=0
c8+c15=0
c9+c16=0
c4=c5=c6=c9=0
c11=c12=c13=c16=0
c4=c5=c6=c8=0
c11=c12=c13=c15=0

45

0.000
0.000
0.133

0.002
0.000
0.679

0.989
0.827
0.667
0.000

0.467
0.007
0.971
0.000

0.029
0.005
0.238
0.000
0.017

0.152
0.941
0.017
0.000
0.105

0.000
0.925

0.000
0.214

Table 7
In- and Out-of-Sample Estimates of Expected Total Issue Cost
and Total Issue Cost Differentials
Regression models from Table 6 are used to generate predicted values of total issue cost for IPOs by the pricing method actually used and estimates of hypothetical total
issue cost under the alternative pricing method. Expected differentials in total issue cost are computed against actual and predicted total issue cost. Cost differentials reflect
cost advantages of auction method pricing, ignoring any effect of pricing method on aftermarket price. Classification results are determined based on comparisons ofpredicted values from the regression models.
Total Issue Cost Estimates and Differentials
Auction Method Sample
Mean
Std. Dev.
MedianBook Building Sample
Mean
Std. Dev.
MedianFull Sample Model applied to Full Sample Data
Actual Issue Cost
Expected Actual Issue Cost
Expected Alternative Issue Cost
Cost Differential in Favor of Auction (Actual v. Expected Alternative)
Cost Differential in Favor of Auction (Expected v. Expected Alternative)

8.17%
10.90%
18.34%
10.17%
7.44%

11.49%
2.14%
14.60%

6.78%
11.60%
20.32%
13.54%
8.72%

28.04%
23.16%
12.22%
15.82%
10.94%

26.80%
9.96%
1.86%

21.67%
25.04%
12.60%
9.07%
12.44%

Subsample Model applied to Full Sample Data
Actual Issue Cost
Expected Actual Issue Cost
Expected Alternative Issue Cost
Cost Differential in Favor of Auction (Actual v. Expected Alternative)
Cost Differential in Favor of Auction (Expected v. Expected Alternative)

8.17%
11.56%
16.85%
8.68%
5.29%

11.49%
1.56%
10.39%

6.78%
11.39%
18.67%
11.89%
7.28%

28.04%
18.54%
12.39%
15.65%
6.15%

26.80%
8.95%
1.49%

21.67%
19.99%
12.70%
8.97%
7.29%

Subsample Model applied to Subsample Data
Actual Issue Cost
Expected Actual Issue Cost
Expected Alternative Issue Cost
Cost Differential in Favor of Auction (Actual v. Expected Alternative)
Cost Differential in Favor of Auction (Expected v. Expected Alternative)

7.00%
11.64%
17.32%
10.32%
5.68%

12.53%
1.63%
11.50%

6.75%
11.49%
19.54%
12.79%
8.05%

15.30%
18.54%
12.25%
3.05%
6.29%

19.56%
8.73%
1.53%

13.64%
20.37%
12.66%
0.98%
7.71%

Classification Results
Sample used in model estimation
Sample on which classifications are based

Full
Full

Auction issues where Auction appears to be lower cost
Auction issues where Book Building appears to be lower cost
Book Building issues where book building appears to be lower cost
Book Building issues where Auction appears to be lower cost.

269
52
22
141

46

Subsample Subsample
Full
Subsample
261
60
33
130

152
32
16
74

Full
Full
83.80%
16.20%
13.50%
86.50%

Subsample Subsample
Full
Subsample
81.31%
18.69%
20.25%
79.75%

82.61%
17.39%
17.78%
82.22%

Table 8Comparisons of Expected Issue Cost and Issuer Characteristics for Subsampleof Auction Method and Book Building IPOs
Observations are grouped according to whether auction method or book building is expected to result in lower total issue cost. The table reports mean and median issuer characteristics
within the groups. Asterisks indicate significance at 10 percent, 5 percent and 1 percent levels in two-tail tests.

Auction IPOs
Estimated Advantage of Auction Method
Expected Actual Issue Cost
Expected Alternative Issue Cost
Actual Issue Cost
Issuer Characteristics
Age of Issuing Firm
Number of Employees
Equity Book Value
Sales Revenue
Underwriter Market Share
Venture Capital Backing
Shares Offered
Gross Proceeds of Offering
New Shares/Shares Outstanding

Book Building IPOs
Estimated Advantage of Auction Method
Expected Actual Issue Cost
Expected Alternative Issue Cost
Actual Issue Cost
Issuer Characteristics
Age of Issuing Firm
Number of Employees
Equity Book Value
Sales Revenue
Underwriter Market Share
Venture Capital Backing
Shares Offered
Gross Proceeds of Offering
New Shares/Shares Outstanding

Apparent Beneficiaries of Auction Method(N=261)
Mean
Std. Dev.
MedianApparent Beneficiaries of Book Building(N=60)
Mean
Std. Dev.
Mediant-value

8.53%
11.74%
20.26%
7.98%

4.54%
1.53%
4.96%
12.08%

8.45%
11.51%
20.58%
6.44%-8.81%
10.80%
1.98%
8.99%

14.24%
1.50%
14.15%
8.52%-4.53%
10.70%
5.65%
7.93%

4.36***
9.87***
0.75

27.6
378.4
722.7
12970
19.4%
47.9%
1134.72471.8
19.1%

11.9
333.1
491.0
9043
10.9%
50.1%
467.6
2224.5
3.8%

26.6
287.0
575.0
10444
17.4%
0.0%
1000.01756.8
18.4%

40.6
841.5
1956.0
43131
17.9%
60.0%
1614.74452.816.50%

12.6
832.4
3383.7
39000
10.1%
49.4%
960.4
8260.8
3.10%

44.5
533.5
981.0
33886
17.4%
100.0%
1350.02242.916.60%

7.32***
4.23***
2.82***
5.95***
1.03
1.70*
3.77***
1.84*
5.62***

Apparent Beneficiaries of Auction(N=130)Mean
Std. Dev.
MedianApparent Beneficiaries of Book Building(N=33)
Mean
Std. Dev.
Mediant-value

9.48%
21.94%
12.46%
31.10%

5.21%
5.66%
1.57%
25.16%

9.13%
21.77%
12.83%
23.61%-6.95%
5.18%
12.12%
16.00%

6.36%
6.74%
1.13%
29.96%-5.35%
6.95%
11.78%
16.08%

13.16***
1.41
2.67**

21.7
276.1
491.0
10672
22.2%
70.8%
1129.72026.7
21.7%

11.7
279.2
333.0
7954
11.3%
45.7%
523.3
3352.6
5.5%

21.0
194.0
416.0
8257
25.8%
100.0%
1000.01010.0
20.7%

37.1
761.3
1003.0
36364
25.0%
90.9%
1840.06228.4
17.4%

15.1
773.9
796.1
18541
6.7%
29.2%
1298.68773.0
4.6%

39.1
553.0
754.0
36494
25.8%
100.0%
1400.02415.017.6%

5.45***
3.54***
3.61***
7.78***
1.80
3.11***
3.08***
2.70**
4.61***

47

Table 9
In- and Out-of-Sample Estimates of Aggregate and Value-Weighted Average Total Issue Cost
and Total Issue Cost Differentials
Regression models from Table 6 are used to generate predicted values of total issue cost for IPOs by the pricing method actually used and estimates of hypothetical total issue cost under the alternative
pricing method. Percentage estimates from the regression analysis are converted to yen based on the aftermarket yen value of the offering. Expected differentials in total issue cost are computed against
actual and predicted total issue cost. Cost differentials reflect cost advantages of auction method pricing, ignoring any effect of pricing method on aftermarket price. Classification results are determinedbased on comparisons of predicted values from the regression models.
Yen-Valued and Aggregate Total Issue Cost Estimates and Differentials
Auction Method Sample
Subsample Model applied to Full Sample Data
Aftermarket Value of Issue (million yen)
Actual Issue Cost (million yen)
Expected Actual Issue Cost (million yen)
Expected Alternative Issue Cost (million yen)
Cost Differential in Favor of Auction (Actual v. Expected Alternative)
Cost Differential in Favor of Auction (Expected v. Expected Alternative)

Mean

Std. Dev.

3023.3
272.5
357.6
269.4
-3.1
-88.2

4354.1550.8
528.1
2479.53172.0
262.6
377.0
183.9
-78.7
-193.15101.6599.0
609.8
3233.7

MedianBook Building Sample
Sum

Entire Sample

Mean

Std. Dev.

MedianSum

2050.0 970493.6
106.0 87472.0
220.9 114784.0
301.6 86465.6
195.6-1006.4
80.7 -28318.4

5431.02714.01049.2713.22000.8336.013107.910029.2
3012.4
1819.41651.0
263.9
258.1
197.4
66.5
60.7

885245.5442380.4
171024.8116245.5326134.9
54779.3

2120.0 583655.1
95.7 48325.5
235.5 69371.1
290.9 33845.0
195.2 -14480.5
55.4 -35526.1

2208.6
293.5
395.5
285.2
-8.3
-110.33580.41843.2
894.9
494.0

Sum

Mean

AuctionBook Building

231029.5
257490.4

477.3
532.0

Differential

26460.9

54.7

Subsample Model applied to Subsample Data
Aftermarket Value of Issue (million yen)
Actual Issue Cost (million yen)
Expected Actual Issue Cost (million yen)
Expected Alternative Issue Cost (million yen)
Cost Differential in Favor of Auction (Actual v. Expected Alternative)
Cost Differential in Favor of Auction (Expected v. Expected Alternative)

Entire Subsample
866.4 198773.8
80.2 26418.6
130.6 35595.4
107.9 25667.2
27.7-751.4-22.7-9928.2

AuctionBook Building

95038.3
69440.4

346.9
253.4

Differential-25597.9-93.4

Value-Weighted Average Total Issue Cost Estimates and Differentials
Auction Method Sample
Mean
Subsample Model applied to Full Sample Data
Actual Issue Cost (percentage)
9.01%
Expected Actual Issue Cost (percentage)
11.83%
Expected Alternative Issue Cost (percentage)
8.91%
Cost Differential in Favor of Auction (Actual v. Expected Alternative)-0.10%
Cost Differential in Favor of Auction (Expected v. Expected Alternative) -2.92%
Subsample Model applied to Subsample Data
Actual Issue Cost (percentage)
8.28%
Expected Actual Issue Cost (percentage)
11.89%
Expected Alternative Issue Cost (percentage)
5.80%
Cost Differential in Favor of Auction (Actual v. Expected Alternative)-2.48%
Cost Differential in Favor of Auction (Expected v. Expected Alternative) -6.09%

Book Building Sample

Entire Sample

Std. Dev.

MedianMean

Std. Dev.

MedianMean

12.65%
12.13%
56.95%

5.17%
10.78%
14.71%
9.54%
3.94%

49.97%
19.32%
13.13%
36.84%
6.19%

76.51%
22.98%
13.88%

15.98%
15.63%
11.96%
4.03%
3.68%

4.51%
11.11%
13.72%
9.21%
2.61%

13.29%
17.91%
12.91%-0.38%-4.99%

51.48%
24.99%
13.80%

AuctionBook Building

12.45%
13.88%

Differential

1.43%
Entire Subsample

11.74%
11.95%
63.39%

48

9.26%
15.07%
12.45%
3.20%-2.62%

AuctionBook Building

12.15%
8.87%

Differential-3.27%

Discussion Paper
No.
2002・1

AuthorNobuyuki Isagawa

2002・2

Nobuyuki Isagawa

2002・3Mahito Okura

2002・4

Elmer Sterken
Ichiro Tokutsu
Mahito Okura
Mahito Okura
Nobuyuki Isagawa
Koji Okubayashi
Toshinori Takashina

2002・5
2002・6
2002・7
2002・8

2002・9Hajime Shimizu

2002・10 Nobuyuki Isagawa
2002･11

Nobuyuki Isagawa

2002･12Kenji Kutsuna
Richard Smith

2002・13 Kunio Miyashita
2002・14 Hajime Shimizu
2002・15 Hajime Shimizu
2002・16 Koji Okubayashi
2002・17 Fumitoshi Mizutani
Shuji Uranishi
2002・18 Kazuhisa Otogawa
2002・19 Atsuo Takenaka
2002・20 Tsuneo Nakano

2002・21 Tsuneo Nakano
2002・22 Fumitoshi Mizutani
Shuji Uranishi
2002・23 Atsushi Takao
Mahito Okura
2002・24 Fumitoshi Mizutani
2002・25 Fumitoshi Mizutani
Takuya Urakami
2002・26 Yasuyuki Miyahara
2002・27 Nobuyuki Isagawa
2002・28 Mitsutoshi Hirano

Title
Cross Holding of Shares, Unwinding Cross Holding of
Shares, and Managerial
Entrenchment
A Theory of Stock Price Behavior following Repurchase
Announcements
An Equilibrium Analysis of the Insurance Market
with Vertical Differentiation
What are the determinants of the number of bankrelations of Japanese firms?
Review Article：Adverse Selection in Insurance Market
Welfare Effect of Firm Size in Insurance Market
Does Investment Horison Affect Investment Strategy ?
Research Report of Careers and Employment Process ofWorkers over 60 years old :a Case of a Japnaese
Manufacturing Company
On the Existence of Tax Equilibrium : Incomplete Market
with Capital Income Tax
Cost of Financial Distress and Debt Restructuring :Debt Forgiveness and Equity-for-Debt Swap
Open-Market Repurchase Announcements, Actual
Repurchases, and Stock Price Behavior in Inefficient
Markets―revised version of No.2001･36―
Why Does Book Building Drive Out Auction Methodsof IPO Issuance?
Evidence and Implications from Japan
International Logistics and Modal Choice
Incomplete markets with capital income tax and public
goods
On the possibility of Pareto improving of tax-equilibrium
China-Japan Comparison of Work Organization
The Post Office vs. Parcel Delivery Companies:
Competition Effects on Costs and Productivity―revised version of No.2001･33―
Earnings Forecast and Earnings Management of JapaneseInitial Public Offerings Firms
The Classification of Foreign R&D Units
The Dutch East India Company and its Corporate
Governance―revised version of No.2000･40―
The British East India Company and its Corporate
Governance
Privatization Effects on TFP Growth and Capital
Adjustments
Some Notes on the Privatization of Postal Life Insurancein JapanPrivately Owned Railways’ Cost Function, Organization
Size and Ownership
A Private-Public Comaprison of Bus Service Operators
Principal-Multiagent Relationships with Costly
Monitoring
Unwinding of Cross Shareholding under Managerial
Entrenchment
Contingency Model for Personnel Grading System―Issues on Design and Management for Qualification
System and Job Grading System―

Date(in Japanese)

1／ 2002(in Japanese)

1／ 20022／20023／2002(in Japanese)(in Japanese)(in Japnaese)

3／20023／20023／20024／2002(in Japnaese)

4／2002(in Japnaese)

4／20025／20025／2002(in Japnaese)(in Japnaese)

6／20026／20026／20027／20027／20028／2002(in Japanese)(in Japanese)

8／20028／2002(in Japanese)

8／20028／2002(in Japanese)

9／20029／20029／2002
10／2002
10／2002(in Japanese)

11／2002

Discussion Paper
No.
Author
2002・29 Atsushi Takao
2002・30 Yasuhiro Shimizu
2002・31 Hideki Murakami

2002・32 Atsushi Takao

2002・33 Nobuyuki Isagawa
2002・34 Takuji Hara
2003・1 Katsuhiko Kokubu
2003・2 Kazuhiro Tanaka
Fumitoshi Mizutani
2003・3
Shuji Uranishi
Yang Jia Yin
2003・4
Koji Okubayashi
2003・5

Mitsutoshi Hirano

2003・6

Kazuhisa Otogawa

2003・7

Nobuyuki Isagawa
Tadayasu Yamashita

2003・8Kenji Kutsuna
Marc Cowling

2003・9

Noriko Masumura

2003・10

Nobuyuki Isagawa
Katsuhiko Okada

2003・11 Mitsutoshi Hirano
2003・12Kenji Kutsuna
Richard Smith

Title
On the Emergency Effect of the late FUKUZAWA,
Yukichi in Introducing of Modern Insurance into Japan
Amortization of Intangible Assets before Newark
Morning Ledger
An Economic Analysis of Duopolistic Competition
between Gulliver and Dwarf airlines:
The case of Japanese Domestic Air Markets
Simulation Model to Consider the Penetration of Modern
Insurance in Japan −Confirmation of Emergence andPhase Transition of New Japanese Risk-Bearing System
by Evolutional Economics
Mutual Shareholding and Unwinding of Mutual
Shareholding as Stockpile for Business Recovery
TLOs in Japan in the life science area : present and future
Environmental Accounting for Corporate Management
Embeddedness and Entrenchment of Managers
The Effects of Privatization on TFP Growth and Capital
Adjustments
Labour Turnover of Japan-Affiliated Companies inShanghai
Generation and Resolution of Asymmetric Information in
Human Resource Management –In the Cases of Job
Rotation in Two Retailers in JapanMarket Liquidity around Quarterly Earnings
Announcements
Lender’s Risk Incentive and Borrower’s Risk Incentive(in Japanese)Date
11／2002(in Japanese)

11／2002
11／2002(in Japanese)

12／2002

12／2002(in Japanese)(in Japanese)(in Japanese)

12／2002
1／20032／20032／2003(in Japanese)

3／2003(in Japanese)

3／20033／2003(in Japanese)

3／2003

Determinants of Small Business Loan Approval:
Evidence from Japanese Survey after 1997 Financial
CrisisVoluntary Corporate Disclosure and the Cost of Debt:(in Japanese)
The Case of Quarterly Reporting
Corporate Financial Strategy and Stock Price Behavior
in a Noise Trader Model with Limited Arbitrage
Two Modes of Economic Organization in the Duality (in Japanese)
Principle and Asymmetric Personal Information
Why Does Book Building Drive Out Auction Methods of
IPO Issuance? Evidence from Japan (Revised version)

3／20034／20034／20035／20035／2003