Book-building, Price Limits Removal, and IPO’s Stock Price Behavior in Taiwan: Share Allocation Mechanism Matters Gili Yen Distinguished Professor Department of Business Administration, Chaoyang University of Technology And Jian-fa Li Assistant Professor Department of Finance, Chaoyang University of Technology And Yi-ju Chen M.A. Program Student Department of Finance, Chaoyang University of Technology

Outline 1. The Research Issue, Research Objective 2. An Analytic Framework of Underwriting Price Determination 3. Hypotheses Development 4. The empirical methodology & Empirical Results 5. Concluding Remarks

Research Issue (1/2) Ibbotson (1975) refers to the phenomenon of under-pricing of the underwriting price as a mystery Ritter & Welch (2002): Before year 2000 After year 2000

Research Issue (2/2) Ritter and Welch (2002) (1) many IPO phenomena are not stationary. (2) research into share allocation issues is the most promising area of research at moment. (3) asymmetric information is not the primary driver of many IPO phenomena.” (p. 1795).

Research Objective (1) whether the magnitude of average short-term excess returns shrinks under the book-building. (2) whether the percentage of the listed firms which has a transaction price falling below the listing price at the end of a certain period of listing in the aftermarket increases under the book-building. (3) whether the speediness of stock price adjustment － as measured in terms of the number of trading days needed for reaching an equilibrium － quickens under the book-building.

Share Allocation Mechanisms in Taiwan 1962: public subscription mechanism. Under the public subscription mechanism, a pure fixed- price approach is adopted. Under the pure fixed-price approach, the listing firm decides the underwriting price through a reference pricing formula provided by the Securities and Futures Commission in Taiwan. 1995: the partial auction mechanism is introduced into Taiwan from Japan 2005: book-building share allocation mechanism Under the book-building system, the underwriting price is jointly determined by the issuer and the block trader.

An Analytic Framework of Underwriting Price Determination Figure 1. The underwriting price relative to the equilibrium price under two different allocation systems. Note: The figure is modified from figure 1 in Yen & Chen (2009).

Hypotheses Development (1/3) Magnitude of the Average Short-Term Excess Returns: Hypothesis 1: After properly treating outliers, the magnitude of the average short-term excess returns becomes smaller in the “book-building” sub- group when compared with its counterpart in the “public subscription” sub-group.

Hypotheses Development (2/3) Percentage of IPOs with a Transaction Price Falling below the Underwriting Price: Hypothesis 2: After a pre-specified time period after listing, say three months, the percentage of IPOs falling below the listing price in the aftermarket under the “book- building” sub-group is greater than its counterpart under the “public subscription” sub-group.

Hypotheses Development (3/3) Speediness of Stock Price Adjustment: Hypothesis 3: The number of transaction days needed for reaching the equilibrium price in the “book- building” sub-group, that is the nth transaction day in the aftermarket which the level of the average short-term excess return is “stabilized”, is significantly small than its counterpart in the “public subscription” sub-group.

Empirical Results Table 1 The Cumulative Average Excess Returns under Two Sub-groups (Outliers Are Removed) (1/4) Public Subscription 1 Bookbuilding 2 Trading Daysmean (%)

Empirical Results: Table 1(continued) (2/4) Public Subscription 1 Bookbuilding 2 Trading Daysmean (%)

Empirical Results: Table 3 The Percentage of IPOs with a Transaction Price Falling below the Underwriting Price (3/4) Table 3 The Percentage of IPOs with a Transaction Price Falling below the Underwriting Price Trading days in Aftermarket Accumulative Numbers of Listing FirmsAccumulative Percentage of Listing FirmsDifferences in Subgroup Means Public SubscriptionBook-buildingPublic SubscriptionBook-Buildingz-statistic 1 day853.80%12.50%-1.61* 3 days %17.50%-1.73* 5 days %22.50%-2.09* 7 days %25.00%-2.16* 1 month %30.00%-2.11* 2 months %32.50%-2.01* 3 months %47.50%-2.80**

Empirical Results: Speediness of Stock Price Adjustment Public Subscription: stabilized in the neighborhood of 32% % about 90% of the “stabilized” excess returns: 9 days Book-building : stabilized in the neighborhood of 45%, exceeds 40.5% － again, about 90% － 1 or 2 days

Concluding Remarks (1/2) (1) There is evidence in favor of the view that the introduction of book- building indeed effectively reduces the magnitude of average short-term excess returns in the IPO’s aftermarket. (2) The introduction of book-building brings the underwriting price closer to the intrinsic value of the IPOs which in turn leads to a higher percentage of IPOs with a transaction price after some certain time length of listing falls below the listing price. (3) The average estimated trading days needed for completing price adjustment of the book-building sub-group, as expected, is much smaller than its counterparts in the public subscription sub-group.

Concluding Remarks (2/2) Based on the above re-enforcing empirical findings, the present study therefore concludes that the introduction of the book-building in place of the co-existence of the public subscription/partial auction has, as expected, exerted perceptible influences on the stock price behavior of the IPOs in the aftermarket.