Green shoe Option and how does it work – SEBI guidelines
Green shoe Option was introduced in the Indian capital market 2003 by SEBI. This mechanism is primarily introduced to protect the investors and give a boost to the primary markets. In this mechanism, one of the books running lead manager (BRLM) is appointed as a Stabilizing Agent (SA).
His main responsibility is to intervene in the market when the share price of the newly issued shares falls below the issue price in the stock market. The BRLM can intervene and act as SA in the market for a maximum of 30 days from the date of the listing. The SA enters into an agreement with the issuer before the filing of the offer document with SEBI.
How does green shoe Option work?
The SA enters into an agreement with one of the promoters. Promoters lend their shares in case of the over subscription in capital market. A maximum 15% of the total issue size can be borrowed. The details of such an agreement are disclosed in the Red herring prospectus.
The shares in If the market prices of the shares fall below the issue price this mechanism activated. When such a situation arises, the SA starts buying the market and thereby creates an artificial demand in the market. Shares bought are credited to the demat account of the green shoe Option. This can continue for maxis uni of 30 days or until the time the funds in this account are exhausted.
The shares bought and which are lying in the green shoe Option Bernat account are then returned to the promoters from whom they are borrowed. If there is profit in this transaction then that is credited to the Investor Protection Fund of the stock market and the issuer company does not get any of this money. In case the SA does not have to buy over-allotted shares, the issuing company has to provide the shares in such a shortfall.
These shares are thee returned to the promoters from whom these shares are borrowed. SA transfers the amount equal to shares issued into the issue price to the account of the issuer. Let us now look at the impact on different sections of the market due to this facility:
If the market price falls below the issue price then this mechanism is used as a technique for stabilization. If the prices open above the issue price then following can be the implications: The issue may have been potentially under priced. The issuer has lost an opportunity to get the higher premium. The secondary market activities show that investors are willing to buy the shares at a premium to its issue price.
Investor’s point of view
The shares borrowed from the promoter can be released in the market. If the market price is below the issue price, this mechanism has the potential to store up the prices and that can be a comfort for the investors.
Lead Bankers point of view
The success of many issues may be dependent on the credibility of the lead managers to the issue. Green shoe Option can help to win the confidence of the investors towards the issue. Gives out a signal to the investors that the issue is fairly priced and the promoters are willing to support the price post-issue.
The case study of ICICI Banks second public issue
This issue was open for subscription between April to the 8th 2004. T 2nd he total capital raised was Rs. 3,050 crones with a green shoe option of Rs.450 crores. Thus, the investors were allotted shares worth Rs. 3,500 crores. Following merchant bankers were involved in this DSP Merrill Lynch (SA) J P Morgan Stanley (BRLM 2) Kotak Mahindra (BRML 3) Life Insurance Corporation was the lender of the shares for the green shoe Option.
On 8th April 2004, the price of the issue was fixed at Rs. 280 and these new shares were listed in the market on 23rd April 2004. The thirty days stabilization period was thus 23rd April to 21st May 2004.
During this period the stock market was quite volatile as it was the election time in India. On 4th May, the BSE Sensex fell due to the political uncertainty and badly hurt the banking stocks in the market. The ICICI Bank’s shares fell by as much as 7.5%. The SA, therefore, intervened in the market.
However, in spite of this on 14th of May, the market price fell to Rs. 265 as against the issue price of Rs. 285 per share. DSPML tried to stabilize the market and purchased 24.79 lakh shares, which were almost 50 % of the traded volume in the shares. However, the price of the shares continued to fall. On 17th May, the Black Monday, the market lost almost 800 points.
The price of ICICI Bank fell by another 10% to a new low of Rs. 238.70 per share. DSPML was buying in the falling market and had already exhausted half the amount meant for this operation by 14th of May. DSPML could intervene only for 30 days and that period was to expire on 21st May 2004. Thus, it can be seen that the green shoe Option may not always protect the shareholders, especially in a falling market.
We must, however, acknowledge that this is at least a good method to try and protect them. A same kind of situation was observed on April 05 in the Punjab National Bank public offering. The price of this share was Rs. 511/- on the day the public offer opened for subscription. The issue price was fixed at Rs. 390 per share through the process of book building. However, when the new shares were listed the market price of the shares was quoting below the issue price.
This issue, however, did not have the green shoe Option and therefore there has been no intervention. Consequently, investors who had applied for this issue and received the shares on the basis of the share price on the day of the opening of the issue are faced with a loss, at least in the short run.
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