Stabilizing Agent
Also written Stabilising agent · Stabilisation agent
Under a green shoe option, the merchant banker who uses over-allotment money to buy the newly listed shares when they fall below the issue price — buying only, for 30 days, up to the over-allotment.
In plain language
The first few weeks after a listing are fragile. If a wave of selling pushes the price below the issue price, new investors panic and the issue's reputation suffers.
A green shoe option gives the issue a shock absorber. The company allots extra shares — borrowed from the promoter — to investors, and parks the money received for them in a separate account. If the price then falls below the issue price, somebody uses that money to buy shares in the market, supporting the price.
That somebody is the Stabilizing Agent (SA), usually one of the merchant bankers or lead managers to the issue. The workbook is careful to stress that he acts independently: he is under no obligation to take directions from the company or the promoter.
How it works
Setting it up. A company opting for a green shoe must disclose it in the offer document. It may allot additional shares not exceeding 15 percent of the issue size to the public who subscribed, in the same ratio as the category reservations. The over-allotment shares are lent by the promoter and/or any investor holding more than 5 percent of the total issued capital.
The two accounts.
| Account | Holds |
|---|---|
| GSO bank account | The money realised from the over-allotment |
| GSO demat account | The shares the SA buys in the secondary market |
The SA's rules.
- Buys shares from the secondary market whenever the market price goes below the issue price.
- Can only buy, never sell.
- Can buy at most up to the extent of the over-allotment.
- Operates only for 30 days from the date the shares are listed and traded.
- Takes no direction from the company or the promoter.
Closing out after 30 days.
- Shares bought are returned to the lender (the promoter).
- Any shortfall between shares bought and shares lent is made good by the company allotting fresh shares against the unutilised money in the GSO bank account, at the original issue price.
- Any balance money left in the GSO bank account — the difference between the issue price and the SA's buying price — goes to the Investor Protection Fund of the designated stock exchange.
- Both GSO accounts are closed.
The formula
Maximum over-allotment = 15% × Issue size
GSO bank account = Over-allotted shares × Issue price
Shortfall shares (fresh issue) = Shares lent − Shares bought by SA
Balance to IPF = GSO money − Cost of shares bought − (Shortfall × Issue price)
= Shares bought × (Issue price − Average buying price)
A worked example
Illustrative figures. An IPO of 1 crore shares at Rs 250 has a green shoe. The promoter lends the maximum over-allotment.
Over-allotment = 15% × 1 crore = 15 lakh shares
GSO bank account = 15 lakh × Rs 250 = Rs 37.50 crore
The stock lists and slips to Rs 238. Over the 30 days the SA buys 9 lakh shares at an average of Rs 236:
Cost of purchases = 9 lakh × Rs 236 = Rs 21.24 crore
Then the price recovers above Rs 250 and he stops — he is not allowed to sell what he bought.
Day 30 close-out.
Returned to promoter from GSO demat account 9 lakh shares
Shortfall against 15 lakh lent 6 lakh shares
Fresh allotment by company at Rs 250 6 lakh × 250 = Rs 15.00 crore from the GSO account
Left in GSO bank account 37.50 − 21.24 − 15.00 = Rs 1.26 crore
Check: 9 lakh × (250 − 236) = Rs 1.26 crore → Investor Protection Fund
The promoter is made whole (9 lakh returned, 6 lakh newly allotted), the market got Rs 21.24 crore of support, and the stabilisation gain goes to investor protection, not to the company or the SA.
Why NISM asks about it
Chapter 9.7 (Green Shoe Option). Every figure in the section is examinable: 15 percent of issue size, lenders holding more than 5 percent, 30 days from listing, buy only, shortfall allotted at the issue price, balance to the Investor Protection Fund of the designated stock exchange. Expect also the independence point — the SA takes no directions from the company or promoter.
Common exam traps
- The SA can only buy. A statement that he sells when the price rises is false.
- 15 percent of issue size is the over-allotment ceiling; the lender must hold more than 5 percent of issued capital.
- 30 days from listing and trading, not from allotment or issue closing.
- Shortfall shares are fresh shares from the company at the issue price, paid for out of the GSO bank account.
- Leftover money goes to the Investor Protection Fund of the designated stock exchange — not to the company, the promoter or the IEPF.
- The SA is usually a merchant banker or lead manager to the issue, and takes no direction from the company or promoter.
Check yourself
1.What may the Stabilizing Agent do under a green shoe option, and what happens to any surplus?
- a)Buy and sell freely on the company's instructions; surplus returned to the company
- b)Only buy shares from the secondary market when the price falls below the issue price, up to the extent of the over-allotment, for 30 days from listing — free of any direction from the company or promoter; any balance in the GSO bank account goes to the Investor Protection Fund of the designated stock exchange
- c)Only sell shares to meet demand; surplus paid to the promoter
- d)Buy shares for an unlimited period; surplus retained as commission
Show the answer
Answer: (b) Only buy shares from the secondary market when the price falls below the issue price, up to the extent of the over-allotment, for 30 days from listing — free of any direction from the company or promoter; any balance in the GSO bank account goes to the Investor Protection Fund of the designated stock exchange
The SA will utilize the money for buying shares from the secondary market whenever the market price goes below the issue price. However, he is under no obligation to take any direction from the issuing company or the promoter for his market operations.
The SA can only buy shares and cannot sell any shares. Moreover, he can buy a maximum up to the extent of the over-allotment made.
Buy-only, and capped — which disposes of options A and C.
The entire process of stabilization will be available only for a period of 30 days from the date on which the shares are listed and traded, so option D's unlimited period is wrong too.
On the surplus: any balance money lying in the GSO bank Account (arising out of difference between the issue and buying price of the SA) will be transferred by the SA to the Investor Protection Fund of the designated stock exchange.
Not to the company, not to the agent — the gain arising from buying below the issue price benefits investors generally.
Who the agent is: the Stabilizing Agent (SA), who is usually one of the merchant bankers or lead managers to the issue.
Where the money and shares sit: the over-allotment proceeds in a GSO bank Account, and shares bought in a separate demat account designated as GSO demat account.
At the end: the SA will take stock of the shares purchased and these shares will be returned to the lender/promoter, and if he could not buy back enough, additional allotment will be made by the company against the unutilised funds lying in the GSO Bank Account... at the same price as per the original issue price.
Then both accounts close.
The whole purpose: to provide stability to the price of the share in the secondary market immediately on listing.
Where this is taught
Free preparation for NISM Series II-ARelated terms
- Investor Protection FundA trust-administered fund at every stock exchange and depository that compensates clients of a trading member who has been declared a defaulter or expelled, up to a per-investor limit the exchange fixes.
- Promoter lock-inThe rule that promoters' shares cannot be sold for a set time after an IPO — 18 months for the minimum 20 percent contribution, or 3 years if most proceeds fund capital expenditure; 6 months or 1 year for the excess.
- Red Herring ProspectusThe offer document used in a book-built public issue, containing every disclosure a prospectus carries except the final price or number of shares, filed with the Registrar before the issue opens.
- Secondary marketThe market where securities already issued are traded between investors — the money goes to the selling investor, not to the company, and the issuer's capital is unchanged.
- Merchant bankerA SEBI-registered body corporate engaged in the business of issue management — arranging the selling, buying or subscribing of securities, or acting as manager, consultant or adviser in relation to an issue.
- Extinguishment certificateThe certificate confirming that shares bought back by a company have been destroyed and capital reduced — signed by the registrar, secretarial auditor and directors for a tender offer, filed with SEBI.