GREEN A Price SHOE Stabilization OPTION Mechanism
FORAM SHAH ROLL NUMBER : 50
Definition
A green shoe is a clause contained in the underwriting agreement of an initial (IPO) that allows underwriters to buy up to an additional 15% of company shares at the offering price (of the total IPO size).
What is it ?
Green shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post listing price. It is a provision, in underwriting agreement, that allows the underwriter to sell the additional shares then the original number of shares offered.
Origination
The term Green Shoe Option derived from a Company named Green Shoe Manufacturing Company, founded in 1919. This company is now called as Stride Rite Corp. This Company was the 1st who initiated this option in 1960. It is also known as GSO.
Why GSO?
This would normally done to reduce the risk of the IPO (Initial Public offering). Also, when the public demand for the shares exceeds expectations and the stock trades above the offering price. It is mainly practiced in US and European Market.
Objectives
Price stability. Reduce the risk.
SEBI Guidelines
A pre-issue contract is required to be entered into for this purpose with an existing shareholders.
Underwriter can issue 15% additional shares of the original offer price. Underwriter can exercise that option within 30 days from the date of allotment of shares.
Requirements
Shareholders approval of further allotment of shares to SA (stabilizing agent). One BR/LM (Book Runner or Lead Manager) to be appointed as SA. Maximum shares that can be over-allotted is 15% of the issue size. Disclosures of specified details in offer document. Stabilization mechanism available for 30 days after trading starts.
Shares to be transferred to lender (s)not later than 2 working days after stabilizing period subject to the remaining lock-in.
SA to file daily and final report to SEs / SEBI.
Working Mechanism
Shares up to 15% of issue size allotted as a part of IPO. Money received on over allotment is deposited in GSO Bank A/C. Promoters / Pre-issue shareholders holding more than 5% shares may lend their shares (Credited to GSO Demat a/c). SA purchases shares from the market, if market price falls below the issue price. Shares are transferred to lender(s); balance shares, if any, are issued to lender(s). Balance in GSO Bank A/C is transferred to IEPF of DSE.
Example
For example, if a company decides to publicly sell 1 lakh shares, the underwriters (or "stabilizers") can exercise their green shoe option and sell 1.15 lakh shares. When the shares are priced and can be publicly traded, the underwriters can buy back 15% of the shares. This enables underwriters to stabilize fluctuating share prices by increasing or decreasing the supply of shares according to initial public demand. If the market price of the shares exceeds the offering price that is originally set before trading, the underwriters could not buy back the shares without incurring a loss. This is where the green shoe option is useful: it allows the underwriters to buy back the shares at the offering price, thus protecting them from the loss.
Continued..
If a public offering trades below the offering price of the company, it is referred to as a "break issue". This can create the assumption that the stock being offered might be unreliable, which can push investors to either sell the shares they already bought or refrain from buying more. To stabilize share prices in this case, the underwriters exercise their option and buy back the shares at the offering price and return the shares to the lender.
Conclusion
The green shoe has the ability to reduce risk for the company issuing the shares. It allows the underwriter to have buying power in order to cover their short position when a stock price falls, without the risk of having to buy stock if the price rises. In return, this helps keep the share price stable, which positively affects both the issuers and investors.
Bibliography
SEBI DIP Guidelines SEBI Website
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