Meaning of Greenshoe Option
Greenshoe option refers to a special option available to underwriters in context of IPO (Initial Public Offering) under which they can issue additional equity shares up to a specific limit. It is also termed as over-allotment option under which more amount of shares than pre decided by issuer are allotted to people in case demand for security rises. Greenshoe option derived its name from Green shoe manufacturing company which was first to exercise the right of overallotment in 1960 when it went public. It grants underwriter a right to issue 15% additional shares than originally planned and it need to be exercised within the time period of 30 days of offering.
Greenshoe option was introduced by SEBI in 2003 as a legal mechanism to be used by companies for stabilizing the aftermath prices of securities offered in IPOs. It enables underwriters in stabilizing share prices by increasing or decreasing their supply as per the demands of public. Role of underwriter begins as soon as the shares are traded in market. In case the share is traded below the offering price, it is known as ‘broke syndicate bid’ and ‘broke issue’. Under such situations underwriter increases offering size by selling 15% of additional shares to public. Once these additional shares in along with initial offerings are priced and becomes effective, 15% additional shares are buy back by underwriter either at or below the offering price, it will lead to stabilize the initial price bid. And if shares are trading above offering price they can’t be purchases back by underwriters as they need to pay higher price for securities.
Example of Greenshoe Option
A well-known real life example of Greenshoe option occurred in Facebook Inc. 2012 IPO. Underwriting syndicate, headed by Morgan Stanley agreed with Facebook, Inc. for purchasing 421 million shares priced at $38 for each share, less 1.1% fees for underwriting. However, around 484 million shares were sold by underwriter to clients which was 15% above initial allocation. A short position of 63 million shares was effectively created by underwriter.
In case, shares of Facebook had traded above the IPO price $38 shortly after listing, an greenshoe option to purchase 63 million shares from Facebook at a price of $38 will be exercised by underwriting syndicate. It leads to cover the short position. However, if shares are trading at higher price then underwriter will avoid repurchasing them.
But as the shares of Facebook decline below the IPO price soon after the trading begins, short position was covered by underwriter without exercising greenshoe option for stabilizing the price and avoiding any steep fall in price.