The Hindu Business Line : Who benefits from greenshoe option?

The Securities and Exchange Board of India (SEBI) guidelines permit exercise of the greenshoe option by a company making a public issue. A pre-issue contract is required to be entered into for this purpose with an existing shareholder — often one of the promoters with a sizeable shareholding — who would be prepared to lend his shares to be used for price stabilisation to be carried out by a stabilising agent on behalf of the company up to a maximum period of 30 days from the date of allotment of shares.

The company then goes on to make allotment, including over allotment, to the extent it has exercised the greenshoe option, which term incidentally has its origin in the name of a company that for the first time exercised such an option in the US. The proceeds of the public issue to the extent it relates to such over-subscription permitted by the greenshoe option is, however, kept in an escrow account to be used in the price stabilisation exercise.

Dousing and mopping

What the company thus marshals are two resources — shares (lent by one of the promoters) to douse the market if the price shoots way above the issue price and cash (in case the secondary market is in no mood to match the enthusiasm generated in the primary market a short while ago) to be used in mopping up shares from the market so as to bolster its sagging strength. The idea, in either case, being to bring the secondary market price to the level of the offer price. Once the stabilisation process is over, which cannot go on beyond 30 days as mandated by SEBI, the shares borrowed from the promoter would be returned to him if there were no occasion for their use.

In case they were used for dousing purposes, the proceeds would be handed over to him. For, this act of risk-taking, he has to be rewarded, which he is, in the form of fees. At the end of the day, who benefits from this exercise? This is not a safety net for retail investors as sometimes loosely described. Because, safety net has an altogether different connotation and, in fact, finds a separate place elsewhere in SEBI guidelines, which permit its offer for a maximum period of six months for shares up to one thousand per individual investor.

Superficial protection

The idea of safety net is that, should during this period the secondary market price fall below the offer price, the promoter or the merchant banker would stand guard and buy the shares from them without demur. This arrangement is any day vastly superior to the greenshoe exercise which admittedly has but the trappings of real safety net and, hence, is superficial in offer of protection to individual investors because the exercise may come a cropper should the shares bought with the limited resources at the disposal of the stabilising agent prove to be inadequate to lift its price to the desired level.

Moreover, on the flip side, when the secondary market is overheated and is sought to be doused by the stabilising agent, it in fact hurts the retail investor should he set out to cash in on his good fortune. It is not even a additional resource mobilising device as described by some, because once again there is a separate dispensation for this purpose, whereunder a company is permitted to retain over-subscription up to a maximum of 10 per cent of the original issue size. The only difference is the greenshoe regime allows this leeway up to 15 per cent.

(The author is a Delhi-based chartered accountant.)

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