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Wednesday, August 15, 2012

How book building works

Financial statement numbers are impacted by book building activity
Securities underwriters "book build" when financial securities are issued

Book building is the valuation of  new financial securities carried out by securities underwriters known as book runners. When a company issues new bonds or shares, they have to be priced. This pricing is performed by the book builder(s) who market the new financial instruments for the issuing company. This price assessment is partially based on a measured demand for the security by both institutional, private and public investors. However, book value for securities is also determined using financial formulas such as the discounted value of future cash flows.

Book building and securities valuation


An initial public offering (IPOs) such as the Dunkin' Brands Group, Inc. IPO in July 2011 serves as an illustration of how  additional issuer based valuation influences book building. The IPO had shares offered at $19 per a July Wall Street Journal report. Arriving at this initial offering price is theoretically the role of book building, but is also be influenced by the issuers capitalization needs. In other words, if the IPO is designed to raise money, the amount of money to be raised can influence the IPO price per share regardless of book building valuations.

Business influences on book building


In light of the competing motives behind IPOs the process of book building involves capitalization requirements, buyer demand for financial securities, and actual valuation of corporate worth as represented by the financial security. Some financial observers also believe book building undervalues valuation. For example, in academic research published by New York University and authored by two professors named Boyan Jovanovic, and Bal√°zs Szentes, it is suggested than an initial public offering be pre-valued below actual worth before soliciting bids from buyers in an effort to share 'super-normal' returns with preferred clients for business purposes. 

Securities valuation and regulatory protection


The actual value of shares to be offered via an IPO are only issued shortly before the offering takes place according to research in the Journal of Corporate Finance. Moreover, according to this research, yet another variable affects the valuation of book building. Specifically, regulatory environment as evident in the form of opt out rules. In other words, the author of the study demonstrates that since book-builders can withdraw their offering of securities if demand is not high enough, the undervaluation that can take place during IPOs is accepted due to the surety made possible via the opt out option.

The function of book building is fundamentally straightforward, however what actually happens when organizational entities seek to raise funds by issuing financial securities via book-building isn't quite so simple. This process and the valuation of securities is carried out by book-builders that are securities underwriters or book-runners. However, the actual price of the securities offered, IPOs in particular, are affected by several factors including book-builder financial motives, the issuer's financial security, and investor demand.

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