Conflict of Interest in Investment Banking
February 12, 2025
Wall Street is very sensitive to communication. Every quarter, executives from top companies communicate their results to the street. Based on the content of this communication, the market reacts. Sometimes the market turns volatile. However, at other times the market remains stable. Apart from the content being communicated, the manner in which it is also […]
The field of strategic financial management has become increasingly popular in the past few years. This has been because of the various advantages that accrue to the practitioners of this philosophy. In this article, we will have a closer look at some of the important advantages which result from following this philosophy. Aligns The Vision […]
Pension funds across the world are facing a significant financial crisis. This is because, for a very long time, they have been investing heavily in equities since the interest rates offered by debt funds were quite low. However, in the recent past, the equity markets have sharply declined. As a result, the asset values of […]
Financial theorists and practitioners all seem to agree on one basic principle, i.e., diversification is the most important tool which helps mitigate risks. Most investors agree on the importance of diversification while making investments. However, they do seem to be on the fence when it comes to diversification while earning income. Some of the biggest […]
In the previous articles, we have already seen what artificial intelligence is and how it can be applied in commercial banking. We are also aware of the various advantages of artificial intelligence. These various advantages are the main reason that artificial intelligence is being adopted by commercial banks all over the world at a breakneck […]
In many cases, IPOs are thought of as being underpriced. This means that as soon as the IPO is listed in the market, investor demand appears, and as a result, the price of the newly listed shares goes up. This is the situation that the issuing company, as well as the investment banker, wants to be in. This is because it creates customer satisfaction amongst the investment community, and they will be inclined towards buying into future issues by the issuing company as well as the investment banker.
However, in some cases, the prices of the newly issued shares start going down. This could be due to external factors such as the overall state of the economy. In such cases, investors often tend to be dissatisfied with the results. Hence, in order to prevent this, a strategy called the greenshoe option is exercised by the investment bankers. In this article, we will understand what the greenshoe option is and what is accomplished by utilizing this option.
Greenshoe option gives special powers to the “stabilizing agent” appointed by the issuing company. In most cases, the lead investment banker is appointed as the “stabilizing agent.” As per these powers, the investment banker has the option of issuing up to 15% additional shares as compared to the initial issue. This means that if the initial issue was determined to be for 10000 shares, the investment bankers could create as many as 1500 additional shares. Hence, a total of 11500 shares are issued to the retail investors in the market. These shares are also allocated to the investors on a pro-rata basis.
However, from the point of view of the company, the money received from the sale of 10000 shares is put into the equity account. On the other hand, the money received from the sale of these additional 1500 shares is kept in a separate stabilizing account. This account is not controlled by the company but is instead controlled by the investment banker. The idea is that the money in this account is to be kept as a reserve. If the price of the shares starts falling below the issue price, this money will be used by the investment bankers to start buying shares in the open market. This will lead to an increase in demand, which would mean that the price of the shares would also go up.
Before the company goes public, it would have to inform the investors that a greenshoe option has been given to the investment bankers. Also, it would have to mention the stabilization period for which this option is to be exercised. The stabilization period cannot exceed 30 days. This means that at the end of 30 days, the investment bankers will no longer be authorized to trade on behalf of the issuing company in order to stabilize their prices.
The greenshoe option begins by borrowing up to 15% additional shares from the promoters. The lock-in period regulations are not applicable to the greenshoe option. Hence, promoters can lend their shares even though they are within the lock-in period. The process can end in one of the three ways depending upon the market conditions:
A greenshoe option is a powerful tool in the hand of the investment banker. As seen above, the banker can use the money to buy back the shares in case of a short position. However, if the prices go on increasing, there is no compulsion for them to buy any shares and return the promoters. Thus, the investment banker is equipped to protect the company from attacks by bearish investors. The final decision regarding the quantum of shares to be bought back, as well as the price at which they have to be bought back, are left to the investment banker.
The bottom line is that the greenshoe option is an exceptional strategy which is used by investment banks to help the newly issued shares to be stabilized in the short run.
Your email address will not be published. Required fields are marked *