Ch. 6: Security Offerings 247
Road show. To market a security offering, senior management and the lead underwrit-
ers travel to major cities to meet with potential investors to discuss the planned offering.
An exemption to the “quiet period” regulations allows managers and underwriters to
make limited oral disclosures during road show presentations, where attendance is re-
stricted to institutional investors. However, in practice most managers and underwriters
try to avoid releasing new information. Thus, this process may be more an information
gathering and marketing effort by an underwriter than an information session that offers
investors new information about the issuer.
Book building process. Underwriters solicit tentative offers from a select group of
institutional investors and other potential investors to buy shares. Bids can be in several
forms: strike bids to buy a specific number of shares at almost any market clearing price,
limit bids where an investor submits a bid for a specific number of shares at a specific
offer price and step-bids where an investor submits a number of limit bids for specific
numbers of shares at different offer prices. The underwriter can use its allocation ability
to reward investors for revealing information on demand in the book building process.
Generally, investors can submit bids until the book closes and can revise or cancel their
bids. This process may cause the issuer to revise the price range, which will necessitate
filing an amendment with the SEC. At the end of this process the underwriters will have
reasonably good estimate of institutional investor demand for the issue. Of course small
retail investors may have a very different demand for the issue.^7
Signing underwriting contract and setting the offer price. The Underwriter accepts
security issue price risk when it signs the Underwriting Agreement to purchase the
entire security issue at an agreed upon fixed price, usually within 24 hours of the start
of the public offering. It is at this point that the final prospectus is printed. On the
morning of the chosen offer date, the underwriter files a “price amendment” with the
SEC on behalf of the issuer specifying the security’s offer price. AsSmith (1977)notes,
this is similar to the underwriter selling a put option on the security issue to the issuer
for a fee. Underwriters reject some potential issuers and vice versa when they disagree
on the level of risk and the appropriate fee or when the underwriters are unable to meet
all the potential demand for their services. Underwriters can also back out of tentative
commitments to underwrite issues up until the day before the public offering date.
Allocation of offering and overselling of offering. The syndicate generally oversells
the issue since the orders are not legally binding and can be withdrawn, though with-
drawals are likely to trigger future loss of allocations in offerings. The lead underwriter
generally determines who is allowed to buy shares in a hot offer and how much of their
order is filled. These investors tend to be good (large) customers of the underwriter.
(^7) For further analysis of the book building process in IPOs, see the studies byBenveniste and Spindt (1989),
Benveniste and Wilhelm (1990), Cornelli and Goldreich (2001), Cornelli and Goldreich (2003)andSherman
and Titman (2002).