What it means
When a company sells new shares to the public, the banks managing the deal want the first days of trading to go smoothly. If sellers rush in and the price falls below the offering price, buyers feel they overpaid and the deal looks weak.
A stabilising bid is a standing order from the lead underwriter to buy shares at a set price so that the market has a buyer when selling pressure appears. The bid is usually placed at or below the offering price, and it is supported by the underwriter's ability to oversell the deal.
By allocating more shares than the base offering, the underwriter creates a short position (it owes shares it does not own). It can then cover that position by buying in the market, and the buying supports the price.
Regulators allow the practice within strict limits because it is a form of price intervention. The bid must be disclosed in the prospectus, cannot be used to push the price above the offering price and must be stopped when the distribution is complete.
Rules in the United States and elsewhere also require that stabilisation activity is reported and kept separate from other trading. For the issuing company, stabilisation offers some comfort that the first weeks of trading will not be disorderly.
Issuers and investors should understand that the support is temporary, because once the bid is withdrawn the shares trade freely at whatever price the market sets. A price that holds up only because of stabilisation may drift lower afterwards.
The nuance is the difference between stabilising and manipulating. Stabilisation that follows the rules is permitted, while placing bids to create a false impression of demand is not.
That is why underwriters must follow strict procedures and disclose their intentions. Stabilisation is closely linked to the greenshoe, also called an over-allotment option.
That option lets the underwriter buy extra shares from the issuer at the offering price if the shares trade well, and the stabilising bid is used if they do not. Together, the two features give the underwriter a way to manage demand after the sale.
In practice
Real-world examples.
Example
A consumer brands company lists on an exchange at $20 a share. On day two, early investors start selling and the price touches $19.90. The lead underwriter's bid at $20 absorbs part of the selling and the price recovers.
Example
A biotech issuer prices a follow-on offering and the underwriter places a stabilising bid at the offering price. Investors holding the shares see steady trading in the first week. When the bid ends, the stock moves with market news rather than with the underwriter's support.
Example
A compliance officer at an investment bank reviews trading records after a large share sale. She confirms that all stabilising purchases were at or below the offering price and within the disclosed period. The records are retained to answer any regulator's questions.
Formula
Calculation
Capital used by the underwriter = Shares bought in the stabilising bid x Bid price
Suppose a company sells shares in an offering at $20 each, and the underwriter has oversold the deal by 500,000 shares. If the price slips and the underwriter buys back 400,000 shares at the stabilising bid of $20, the capital used is 400,000 x $20 = $8,000,000. The remaining 100,000 shares of the short position can be covered through the over-allotment option, which would cost 100,000 x $20 = $2,000,000.Case study
Seen in the real world.
Stonebridge Foods is a fictional company that listed on an imaginary exchange, selling 10 million shares at $15. Its lead underwriter, Alder Hill Securities, sold 11.5 million shares to investors, creating an oversold position and placed a stabilising bid at $15. This is an illustrative scenario, not a real offering.
In the first week the shares dipped to the offering price twice and the bid absorbed the selling. After 30 days the bid was withdrawn, and the remaining short position was partly covered by buying in the market and partly by exercising the over-allotment option. The shares traded freely afterwards, and Stonebridge's board noted that the support had helped a calm start but was not a guarantee of future prices.
Watch out
Common mistakes.
- Thinking a stabilising bid guarantees the share price. It supports the price only at a certain level and only for a limited time.
- Assuming stabilisation is market manipulation. It is permitted when carried out within the disclosed rules, though misusing it is illegal.
- Believing the bid can be placed above the offering price. The bid generally cannot exceed the offering price, so it cannot push the price higher.
Questions
People also ask.
Who places a stabilising bid?
The lead underwriter, or an agent acting for the underwriting group, places it and discloses the possibility in the offering documents.
How long does stabilisation last?
It runs only during the distribution period, which is typically a few weeks, after which the bid is withdrawn.
What is the link to a greenshoe option?
The greenshoe lets the underwriter buy extra shares from the issuer if the deal does well, while stabilising purchases cover the oversold position if the price falls.
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