Greenshoes turn into red rags
Jake van der Kamp
Stabilising the share price of new issues on the market may seem a laudable objective. Nobody throws newly born babies out on the street to figure life out themselves. Care and attention is needed.
It is particularly so with new issues because speculators have a habit of buying them with the intention of selling again within only a few days. This can create a great deal of price volatility and little good for the reputation of newly floated companies in those critical first days of trading.
This is the rationale for having over-allotment options, commonly referred to as the 'greenshoe'. They are intended as a form of insurance policy against that initial speculative selling.
If, for instance, you are introducing one billion shares to the market, as the Mass Transit Railway Corp has done, the practice allows you within 30 days, let us say, to call on the issuer, the Hong Kong Government in this case, for an additional 150 million shares at the original offer price of HK$9.38. You sell those 150 million shares to investors at the same time as the one billion other shares in the issue. The only difference is that delivery of, and payment for, the 150 million will be delayed by up to 30 days. They are almost the same as the other shares but not quite.
If the price of the stock goes up in the market over those 30 days you call on the issuer for the full 150 million shares and deliver them to the buyers. If the price instead goes down you go into the market yourself and buy the shares to drive the price up again.
If you then have bought 50 million shares this way you call on the issuer for only 100 million shares and, once again, deliver the full 150 million at the end of 30 days.
This is the way it is meant to work. There are occasionally reasons for suspecting that it does not. Greenshoes can be abused although your correspondent has no evidence that it happened in the MTRC's case.
We shall leave aside for the moment the question of whether exerting a pronounced one-way influence on the movement of a share price when that influence has nothing to do with the merits of the stock does not constitute market manipulation. You may be excused for thinking it does.
There is another question to pose here. Imagine yourself a speculator who is thinking of 'stagging' an issue - buying some shares and flipping them out again for a quick profit within a few days, the practice against which a greenshoe is meant to protect. What sort of inducement might lead you to do it?
Scratch your head as much as you like, there is nothing you could come up with as a better inducement than knowing that someone will buy up to 150 million shares if the price goes down over those few days but will sell none if the price goes up.
Outside the world of fantasy there cannot be a better guarantee than this one that you are likely to make money by stagging a new issue. Over-allotment options are not greenshoes to speculative bulls. They are instead red rags to drive those bulls into an even greater fury of buy-and-flip speculation.
How much plainer can you want it? Greenshoes do not discourage volatility in initial trading. They rather encourage it. Nothing could be better custom designed to the purpose. They have exactly the opposite effect of the one they are billed to have.
But somehow it seems that this easy step of logic is never made plain to issuers of new stock by the investment bankers who jolly them into approving greenshoes.
The simple fact of the matter is that we eased our way backwards into adopting this practice in recent years without thinking about it much because it is US practice and we are increasingly going the US way.
But we are not the United States. Our regulatory regime is much weaker, greenshoes can be abused by their promoters and we need to think about this again.