In August 2003, the Securities and Exchange Board of India (SEBI) introduced the concept of green shoe option (GSO) to the Indian capital markets, with a view to arresting short-term volatility in post-listing prices. The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, provide the framework for GSO.
This article discusses the various aspects of the GSO mechanism.
Outline of the concept
Upon listing, the market price of shares may fluctuate substantially, undermining investors’ confidence in a company. GSO is an option whereby equity shares in excess of the equity shares offered in the public issue are allotted as a post-listing stabilizing mechanism. The GSO mechanism can be adopted in initial public offerings and further public offerings by appointing a stabilizing agent which is usually a book running lead manager to the issue.
GSO can be exercised only if specified in the offer document and shares are oversubscribed in the public offering. By this process, shares in excess of the issue size are allotted to investors (over-allotment), as determined at the pricing date by the company the promoters/existing shareholders (lender) and the stabilizing agent.
The stabilizing agent borrows shares from the lender and uses them for over-allotment. The application monies received from investors for over-allotment are deposited into a separate escrow bank account.
Falling market price
If the shares are trading at a price lower than the issue price, the stabilizing agent starts purchasing shares from secondary market, using the money in the separate escrow bank account. At the end of the stabilization period, the shares so purchased are handed over to the lender.
In this manner, the stabilizing agent tries to stabilize the falling prices by purchasing shares from the secondary market. Ordinarily, when the market prices of newly listed shares fall, the paid-up share capital of the company will not increase after the completion of the price stabilization exercise.
However, on expiry of the stabilization period, if the stabilizing agent is not able to buy shares from the market because the price is higher than the issue price, the company will have to allot shares at the issue price, without complying with provisions of the preferential issue, to the extent of the shortfall to the special account within five days of the closure of the stabilization period. Such shares are returned to the promoters or existing shareholders.
Perspective of stakeholders
The concept of GSO works differently for each stakeholder. For an investor, chances of getting shares in the public issue increase in a case where the green shoe comes into play and shares are over-allotted, and volatility in the price of the shares is reduces post-listing. From the lender’s point of view, the lender helps the company to meet the demand for shares and helps the company maintain investors’ confidence. For the company, risk of volatility in the price of the shares is reduced because investors’ trust in the company is maintained.
The company should obtain shareholder authorization to make a GSO, and the company, stabilizing agent and lender should execute a tripartite stabilization agreement. Requisite disclosures pertaining to the GSO should be made in the draft and final offer documents.
A maximum 15% of the issue size may be made available under GSO. The maximum stabilization period is 30 days from the date on which trading permission is given by the recognized stock exchanges concerned.
Any amount left in the special bank account after remittance of monies to the company and deduction of expenses incurred by the stabilizing agent must be transferred to the Investor Protection and Education Fund.
Pros and cons
GSO is available only if a public issue is oversubscribed. In the event of exact or undersubscription, price stabilization through GSO is not available, even if authorized by shareholders.
In the recent past, in many public issues, the post-listing price has declined considerably below the issue price. In such cases, stabilization could have helped bring the secondary market price to the level of the issue price.
However, stabilization through GSO is not possible if a company does not opt for green shoe option or there is no oversubscription in the public issue.
Stabilization under GSO also may not work if the issue price is overvalued. The cap of 15% and window of a one-month stabilization period may not be sufficient for price stabilization of highly overvalued or undervalued shares.
Ashwinee Oturkar is an associate at Khaitan & Co. Khaitan & Co is a full-service law firm with offices in Mumbai, Delhi, Bangalore and Kolkata. Views expressed in the article are those of the author and may not necessarily reflect the views of the firm.
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