Putable Common Stock

What is Putable Common Stock?

Putable common stock is stock that gives investors the option to sell (or "put") the stock back to the company at a predetermined price.

Understanding Putable Common Stock

With putable common stock, investors have the option of selling their shares back to the issuer at a predetermined price. Typically, this price is relatively low, so the put option acts merely as a type of insurance in the event the price falls significantly. Investors will often sell when the stock price falls below the predetermined price. The put option makes the stock more attractive to investors, facilitating the raising of capital by the issuing company.

Putable common stock was invented in 1984 by Drexel Burnham Lambert, an investment banking firm, for the public offering of its client Arley Merchandise Corporation. However, the Securities and Exchange Commission intervened and told Arley to treat the European style puts as debt on its balance sheet. Drexel addressed this problem in a subsequent client case involving Gearheart Industries. In this case, it made the offering redeemable in cash, debt, preferred stock, or common stock.

Putable common stock is commonly used to solve the underpricing problem in initial public offerings. If the price of a stock falls below a certain guaranteed value promised by the issuer, then the investor is assigned more stock. If the stock rises above the guaranteed value, then nothing happens. In that respect, putable stock resemble convertible bonds rather than equity, but are classified as the latter on a company's balance sheet.

Companies may also issue callable common stock, which allows them to buy back stock at a predetermined price. This allows the company to budget for buybacks more effectively.

Advantages of Putable Common Stock

Researchers have identified a couple of advantages to putable common stock. The first is that the stock solves the informational asymmetry problem between investors and founders. This is primarily because founders bear the maximum risk of a decline in their company's price.

The second advantage of putable common stock is that it provides an efficient method to transfer ownership in a decline of the stock's price. During that period, the price of shares would fall rapidly near the date of put expiration. Owners of putable common stock would receive new shares to make up the losses and ensure a constant predetermined value to their holdings, while company founders would have to sell their shares to make up for the losses.