GREEN SHOE OPTION - An IPO's Best Friend

Many have heard of IPO or Initial Public Offering which is the function of the primary market. IPO is when a company wish to issue its shares to the general public for subscriptions for a price pre-determined by the company. Such shares subscribed by general public and allotted by the company based on criteria set by the issuing company thus get listed to the stock exchange for trading purpose of the investors or shareholders as they are rightly called.

Companies that wants to make a public appearance and wants to sell its shares for public have certain systems to stabilize their initial price movements. One such mechanism is the Green Shoe Option. A greenshoe is a clause or a condition added in the underwriting agreement of an initial public offering (IPO) that allows underwriters to buy up to an additional 15% of company shares at the offering price. This option is mainly exercised when the public demands for the shares of a company exceeds expectations and the stock trades above the offering price. In other words this option can be exercised once the share is over subscribed at the IPO stage but has a cap of 15%.

WHY THE NAME GREEN SHOE

The name "greenshoe" came from the Green Shoe Manufacturing Company (now called Stride Rite Corporation), founded in 1919. It was the first company to implement such a clause into their underwriting agreement on over subscription or exceeding public demand for the companies shares.

In a company prospectus, the legal term for the greenshoe is "over-allotment option", because in addition to the shares originally offered, shares are set aside for underwriters. This type of option is the only means permitted by the Securities and Exchange Board of India (SEBI)  for an underwriter to legally stabilize the price of a new issue after the offering price has been determined. The SEBI adopted this option from abroad and introduced this option into the Indian Capital Markets in the year 2003 so as to enhance the efficiency and competitiveness of the fundraising process for IPOs.


'Impact of Green Shoe Option in Indian Capital Market' is my final year research project for my Masters program in Finance.Many of the Indian corporate houses, Analysts and people involved with the Financial Markets are not aware of such an option.  In my next article we will see how the Green Shoe Option mechanism works which will give you a fair idea on its ability to stabilize the price movements. Keep Tracking.