Stabilization agent in an IPO


    What’s a stabilization agent in an IPO?

    During an initial public offering (IPO), there is no rule about how a price should move, but the company and its underwriters typically want it to be a success to motivate its staff and investors. That is why many companies are seen to underprice their IPOs so that the first day ends with the stock in profit. This is however not a strict rule.

    After the IPO, the underwriter can be asked to support the trading of the share for a certain period of time. That is the so-called stabilizing agent. They have obligations such as:

    • Providing liquidity to avoid strong price movement.
    • Supporting the price by buying the stock below a certain level. This price support is often done by a repurchasing some of the shares of poorly performing IPOs.

    Greenshoe or over-allotment option

    A greenshoe option is a special provision in an IPO prospectus allowing underwriters to sell more shares than originally planned by the company and then buy them back at the original IPO price if the price has gone up afterwards or simply make a profit if the price went down. This is normally done if the demand for a stock proves much higher than expected. A greenshoe option is legally called an “over-allotment option” and allows underwriters to short sell shares at the offering price. The greenshoe can vary in size and is normally not more than 15% of the original number of shares offered.

    An over-allotment option is very popular because it is one of few SEC-permitted, risk-free means for an underwriter to stabilize the price of the stock. Companies will sometimes not allow a greenshoe option in an IPO if they have a specific objective for the gains from the IPO and wish to avoid raising more money than needed.

    The first company to offer an over-allotment option was Green Shoe Manufacturing (now called Stride Rite Corporation) and that’s where the name comes from.

    What does a stabilization agent and the availability of a greenshoe option/overallotment option mean for your trading?

    If a company’s shares at IPO are popular and more shares are issued by the stabilization agent, then afterwards, the following could happen:

    • If the price goes down, the stabilization agent buys back shares that were over-allotted as part of the greenshoe option and makes a profit while stabilizing the price.
    • If the price goes up, the stabilization agent exercises the greenshoe option to buy the shares at the original IPO price and does not make a loss.

    Related role: Underwriter

    Next to being the stabilization agent, investment banks fight hard to become the underwriter of a company’s IPO.