KOREA CAPITAL MARKET INSTITUTE

Capital market globalization in the 1990s has repositioned the bookbuilding method developed in the US IPO market as a new standard and spread it to other countries. Many countries abandoned auctions or the fixed price method they had used and shifted towards bookbuilding. In 1999, the Korean IPO market followed the suit to adopt bookbuilding method for IPO valuation. 

The efficiency of the american bookbuilding method is known to be achieved by the reputable underwriters. That is, in the IPO market with information asymmetry, the reputable underwriters capitalize on their reliable investor networks for price discovery and allocation of IPO stocks. In short, the reputable underwriters play a “gatekeeper” role to achieve market efficiency. 

Unlike the US bookbuilding method that the underwriters have developed to achieve the intermediary function of the investment banking, Korea’s bookbuilding process was introduced and regulated by regulatory arrangements. This seems to leave Korean underwriters different from U.S. underwriters playing a significant role. The Korea’s different backgrounds take us to important questions about the efficiency of bookbuilding in Korea. Against the backdrop, our research question is as follows, “Has the Korea’s IPO market evolved into a gatekeeper market since the introduction of bookbuilding?” To answer it, we review regulatory changes since 1970’s and recent Korean IPO market features, and we examines the information efficiency of Korean bookbuilding method and the competition structure of the IPO market.

After the introduction of the bookbuilding, the Korean IPO market is observed to exhibit the following features. First, the IPO volume has decreased steadily. Second, Korean IPO firms show high ROA and low leverage, while IPO firms in advanced capital markets such as U.S. and U.K. show negative ROA and high leverage. Third, the magnitude of the Korea’s IPO underpricing is, albeit on a downward trend, high relative to advanced capital markets. Fourth, the market concentration index showing the degree of competition between underwriters has increased steadily and is internationally high. Fifth, Korean IPO spreads at one of the lowest levels in the world have recently been on a downward trend. These features cast doubt on whether the Korean IPO market structure has improved.

Our analysis on information efficiency reveals major changes as follows. Since 2007, a differentiation has been observed between the initial price range and institutional bids submitted in the bookbuilding process, which confirms bids’ higher information efficiency than that of the initial price range. It seems to suggest that information efficiency of Korea’s bookbuilding method has improved due to the shift towards a gatekeeper market. But, there is also evidence that rejects such shift. According to the descriptive statistics, most underwriters set the initial price range at a similar discount of the price-to-earnings and market-to-book multiples of comparable firms, and tend to set the offer price below the upper bound of the initial price range. In fact, it is difficult to find out where those results stem from: It could be either the formation of a gatekeeper market, or the regulatory reform and resultant changes in market participants’ behavior. If the latter is the case, then this should mean the appearance of the underwriters differentiating their services from the others to gain leadership in IPO market, which is directly examined through the analysis on the market’s competition structure. 

However, the results rejects our hypothesis that underwriters have evolved into a gatekeeper firm found in the U.S. IPO market. Although top underwriters in the Korean IPO market have secured their competitive edge, they have failed to differentiate their services enough to beat the low pricing strategy of competitors. Unlike the U.S. market, there is no evidence that top underwriters have competed with service quality, which seemed to have intensified the price competition in Korea’s IPO market: No improvements in service have been observed, for instances, voluntary market stabilization efforts, active analyst coverage after IPO, and long-term relationship building with some institutional investors. This leads us to the conclusion that Korea’s improved information efficiency stems from the regulatory overhaul rather than some improvements in underwriters’ service quality.

Given the characteristics of the Korea’s IPO market found in the analysis, it would be appropriate to define the Korean IPO market as an “infrastructure management market” rather than a “gatekeeper market”. The infrastructure here refers to authorities such as KRX and FSS. But such Korea’s IPO market structure should be changed due to two reasons. First, technology-based, innovative firms with high investment risk cannot go to public under the current IPO market structure where a significant part of underwriting is carried out by public infrastructure. Second, the market structure is losing its internal consistency under some competition. A demutualized exchange cannot prioritize its public functions. Hence, we propose to set Korea’s policy objectives as shifting the IPO market towards a “market discipline system”. 

More specifically, we suggest that,

1. Underwriter’s discretion in the bookbuilding operations in the IPO process be increased to the level on par with the American system;

2. Underwriters determine the offer price fully at their discretion without any intervention of regulatory authorities (KRX or FSS), and FSS improve the oversight so that the details  on determining the offer price may not be disclosed in the securities registration statement;

3. To ensure investor protection, regulatory authorities bolster oversight and supervision over unfair practices in exchange for granting wider discretion to underwriters; 

4. Regulatory authorities secure more effective sanction tools to ensure underwriters’ legal liabilities and accountability in relation to due diligence; 

5. The current regulation mandating bookbuilding be liberalized so that issuers can freely choose from bookbuilding, an auction, or a fixed-price method.