What Is a Price Band?
A price band is a value-setting method in which a seller indicates an upper and lower cost limit, between which buyers are able to place bids. The price band’s floor and cap provide guidance to the buyers. This type of auction pricing technique is often used with initial public offerings (IPOs).
Understanding Price Bands
The price band is used during the price discovery stage of an initial public offering (IPO). When a company decides to issue shares in the primary marketit hires the services of one or more investment bankers to act as underwriters.
- A price band is a value-setting method in which a seller indicates an upper and lower limit of where buyers are able to bid.
- This pricing technique is often used with initial public offerings (IPOs).
- Determining the price band is critical to understanding how much investors are willing to pay.
The underwriter analyzes factors such as the growth forecast of the company, industry, and economy; the firm’s net worth; earnings per share (EPS); and many other aspects of the company to determine a range of prices that the security can trade for. The price range the issuer and underwriter agree upon is referred to as the price band.
The bottom band is the lower limit and the top band is known as the upper limit. Determining the price band is a critical step in book buildingas it enables a firm to understand how much money investors are willing to pay for an ownership stake in the firm.
Once a price band is formulated, the underwriter starts the process of building its books, which it opens by sending a draft prospectus with the price band to potential investors, such as institutional investors, retail investors, and high net worth individuals (HNWI).
The book is open for a predetermined period, during which investors can submit and revise their offers on the number of shares they are willing to purchase at a price that falls within the band. After the book is closed, the underwriters evaluate the bids in order to “discover” the fair price of the IPO.
Example of a Price Band
As an example of how underwriters use the price band to build the books, imagine a company wants to issue 10,000 shares in its IPO, and the price band is set at $35 to $42. The bids that are received from investors are:
Number of shares
Cumulative % of total shares
The company is issuing only 10,000 shares, but total bids of 22,000 shares have been submitted. The highest price at which the company is able to sell its issue is $39, and this price is set as the cutoff price. All bidders below $39 on the price band will have their money refunded and will not be allocated any shares. Bidders who submitted prices at $39 or more will receive shares for $39.
Price bands can also be used in international trade. A country can set an upper and lower price that it will allow a good to be sold at in the market. If the price of an imported good is below the lower price threshold, the country could tax the good until it falls back within the price band. Protection is provided by imposing a variable import levy on the imported commodity, which raises the importer’s cost to the reference price.