Book building is a systematic way of pricing and allocating shares in a new issue. It helps firms to raise capital in the most efficient and cost-effective way. The process begins with the preparation of a book based on the requests that come in from institutional investors, who then state their bids for the number of shares of a certain company. Firms use the data obtained in the book building process to determine the kind of reception the company’s new shares will have when they are listed on the stock exchange.

Book building process involves inbound enquiries from potential investors, and records the bids in a book maintained by the merchant banker (lead managers). Before the commencement of the book building process, the merchant banker determines the issue price band and should discuss it with the stock exchange. The issue price band is generally determined by the issuer in consultation with the book-running lead manager (issuer, in this case). The issue price band is specified by way of percentage of the floor price (the lower limit of the price band) and the cap price (the upper limit of the price band).

The bids recorded by the book-running lead managers consist of the number of equity shares desired by the investors and the price that they are willing to pay. Investors can express their preference for the issue price, often indicating a price which is in the middle of the price band to maximize the chances of allocation. On the basis of the bids received, the book-running lead managers undertake a uniform price auction, which is normally an ascending price auction (where the price increases over time).

The aim of the book building process is to maximize the price at which the new shares are sold and thereby allowing investors to get value for their investment. The book-building mechanism also provides a means of evidence for underwriters to set the initial public offering price as well as the number of shares to be offered for sale in the market to meet the required amount of equity capital. In addition, book building eliminates the possibility of monopoly pricing by the underwriter, as the bids usually reflect the market demand.

Book building helps in understanding the market appetite for new stocks and investors can benefit from these insights thereby encouraging idea-orientation by the investors. Book building process is simply the most efficient and cost-effective way to launch new stocks on the market. It not only helps to maximize the issue price, but also helps to ensure smooth market functioning and efficient price discovery.