The first day of trading after an initial public offering (IPO) is much like the first day for a horse at a race. You eagerly wait to see your horse run like the wind. But things may not turn out as expected. Even the IPOs of well-known companies may lose steam on the very first day of trading. It is true that in the long run, companies that have good potential eventually make a comeback. But falling prices of shares immediately after listing make even the most optimistic bull look like a jittery mouse.
Johnny: So the initial few days after the listing are very crucial for an IPO. Is there any way to ensure that the prices do not fall below the offer price immediately after listing?
Jinny: Well, many companies use what is called a “greenshoe option”. Although a greenshoe option in itself can’t put life into a dead IPO, it can be a very useful tool for stabilizing prices immediately after the listing of shares.
Johnny: Can you elaborate on what exactly a greenshoe option is?
Jinny: A greenshoe option is a well-known term in the world of stock markets. In legal parlance, it is also known as an “over-allotment option”. As you may be aware, in a public offering a company sells its shares to investors, which get listed on a stock exchange for subsequent trading. Green Shoe Co., an American company, was the first to use this kind of option in their public offering, hence the name greenshoe option. This option gives the issuer company a right to sell more shares to investors than originally planned in their public offering if the demand situation requires such an action after the listing. The greenshoe option can greatly help in stabilizing the prices after listing. For public offerings in the Indian stock market, a company interested in using the greenshoe option has to follow the guidelines prescribed by the Securities and Exchange Board of India (Sebi), the stock market regulator. As per Sebi, the size of excess allotment or the greenshoe option shall not exceed 15% of the total issue size.
Johnny: You have whetted my appetite by giving an overview, but now you have to tell me how the mechanism of a greenshoe option actually works.
Illustration: Jayachandran / Mint
Jinny: A company wanting to use a greenshoe option has to first and foremost appoint a “stabilizing agent” by entering into an agreement with one of its merchant bankers managing the public offering. A stabilizing agent plays a crucial role in the working of a greenshoe option. In fact, it is the stabilizing agent that is in the driver’s seat during the stabilization period. For his services, a stabilizing agent earns a fee from the company. According to Sebi guidelines, the stabilization period shall not exceed 30 days from the date when trading permission was given by the stock exchanges.
Johnny: Thirty days may not seem very long, but they are very crucial for newly listed shares. But what does the stabilizing agent do during the stabilization period?
Jinny: As I said earlier, the entire process of a greenshoe option works on over-allotment of shares. Say, for instance, that a company is planning to issue only 100,000 shares, but in order to utilize the greenshoe option, it actually issues 115,000 shares, in which case the over-allotment would be 15,000 shares. The company does not issue any new shares for the over-allotment.
The 15,000 shares used for the over-allotment are actually borrowed from the pre-issue existing shareholders and promoters with whom the stabilizing agent enters into a separate agreement. For the subscribers of a public issue, it makes no difference whether the company is allotting shares out of the freshly issued 100,000 shares or from the 15,000 shares borrowed from the promoters. Once allotted, a share is just a share for an investor.
For the company, however, the situation is totally different. The money received from the over-allotment is required to be kept in a separate bank account. The main job of the stabilizing agent begins only after trading in the share starts at the stock exchanges. In case the shares are trading at a price lower than the offer price, the stabilizing agent starts buying the shares by using the money lying in the separate bank account. In this manner, by buying the shares when others are selling, the stabilizing agent tries to put the brakes on falling prices. The shares so bought from the market are handed over to the promoters from whom they were borrowed. In case the newly listed shares start trading at a price higher than the offer price, the stabilizing agent does not buy any shares.
Then how would he return the shares? At this point, the company by exercising the greenshoe option issues new shares to the stabilizing agent, which are in turn handed over to the promoters from whom the shares were borrowed.
Johnny: Thanks, Jinny. The greenshoe option can be of great help in avoiding listing blues.
What: The greenshoe option is a useful tool for stabilizing the prices of shares immediately after listing.
How: The issuer company issues more shares than originally planned; these are subsequently bought back after the listing if shares trade at a price lower than the offer price.
How much: The size of the excess allotment shall not exceed 15% of the issue size.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at firstname.lastname@example.org