The Concept of Green Shoe Option

Topics: Stock market, Initial public offering, Greenshoe Pages: 13 (3138 words) Published: April 5, 2012
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“Green Shoe Option means an option of allotting equity shares in excess of the equity shares offered in the public issue as a post listing price stabilizing mechanism”

A Green Shoe (sometimes "green shoe"), legally called an "over-allotment option" (the only way it can be referred to in a prospectus), gives underwriters the right to sell additional shares in a registered securities offering at the offering price, if demand for the securities exceeds the original amount offered. The greenshoe can vary in size up to 15% of the original number of shares offered.

The greenshoe option is popular because it is one of a few SEC-permitted means for an underwriter to stabilize the price of a new issue post-pricing, and it presents no risk to the underwriter. Issuers will sometimes not permit a greenshoe on a transaction when they have a specific objective for the offering and do not want the possibility of raising more money than planned. The term comes from the first company, Green Shoe Manufacturing now called Stride Rite Corporation to permit underwriters to use this practice in its offering.

The SEC also permits the underwriters to engage in naked short sales of the offering. The underwriter creates a naked short position either by selling short more shares than the amount stated in the greenshoe option, or by selling short shares where there is no greenshoe option. It is theoretically possible for the underwriters to naked short sell a large percentage of the offering.

The SEC also permits the underwriting syndicate to place stabilizing bids on the stock in the after-market. However, underwriters of initial and secondary offerings in the United States rarely use stabilizing bids to stabilize new issues, and instead engage in short selling the offering and purchasing in the after-market to stabilize new offerings. "Recently, the SEC “staff has learned that in the US syndicate covering transactions have replaced (in terms of frequency of use) stabilization as a means to support post-offering market prices. Syndicate covering transactions may be preferred by managing underwriters primarily because they are not subject to the price and other conditions that apply to stabilization


* Issuer Company use green shoe option mechanism during IPO to ensure that the shares price on the stock exchanges does not fall below the issue price after issue of shares.


* The Green shoe option is exercised by a company making a public issue. A contract has been entered in relation to green shoe option with the existing shareholders (i.e. with promoters) before the public issue of shares.

* The guidelines require the promoter to lend his shares (not exceeding 15% of issue size) which is to be used for price stabilization to be carried out by a stabilizing agent (normally merchant banker or book runner) on behalf of the Company.

* The stabilization period can be for a period of maximum period of 30 days from the date of allotment of shares to bring stability in post listing pricing of shares.

* The company then goes on to make allotment, including over allotment, to the extent it has exercised the green shoe option.

* Example - The entire process of a greenshoe option works on overallotment of shares. Say, for instance, that a company is planning to issue only 100,000 shares, but in order to utilize the greenshoe option; it actually issues 115,000 shares, in which case the overallotment would be 15,000 shares. Please note that the company does not issue any new shares for the over-allotment.

The 15,000 shares used for the over-allotment are actually borrowed from the promoters with whom the stabilizing agent enters into a separate agreement. For the subscribers of a public issue, it makes no difference whether the company is allotting shares out of the freshly issued 100,000...
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