Definition
The Greenshoe option is a clause present in the underwriting agreement of an Initial Public Offering (IPO), which allows underwriters to purchase up to an additional 15% of company shares at the offering price. It is used to stabilize the price of new issues, preventing them from falling below the offering price. This option is named after the Green Shoe Manufacturing Company, where it was first introduced.
Phonetic
The phonetics for the keyword “Greenshoe Option” would be: /’gri:nʃu: ˈɒpʃən/.
Key Takeaways
<ol><li>Greenshoe Option is a unique provision in an underwriting agreement that allows the underwriter to sell more shares to investors than initially planned by the issuer. This can help prevent stock shortages and provide stability to the stock’s price during the post-listing phase.</li><li>The Greenshoe Option is implemented only when the share price is above the issue price, effectively acting as a safety net for investors and underwriters in an IPO. It allows underwriters to adjust the supply of shares in response to public demand.</li><li>While the Greenshoe Option benefits underwriters and offers stability to the market, it can dilute the holdings of the initial shareholders. Such an option is named after the storied company Green Shoe Manufacturing, now known as Stride Rite, which first implemented such a clause.</li></ol>
Importance
The Greenshoe Option, otherwise known as an over-allotment option, is significant in business and finance due to its capability to provide price stability during the initial post-IPO trading period. This option allows underwriters to sell additional shares, up to 15% more than the original amount set, if the demand is substantial. If the share price drops below the offer price, underwriters could buy back the extra shares at the offer price, reducing the supply and hopefully increase the share price. This stabilizes prices by controlling excess volatility and protects both investors and the issuing company from potential market fluctuations that may devalue the offers. Therefore, the greenshoe option plays a consequential role in successful IPO operations.
Explanation
The Greenshoe option primarily serves as a safety valve for companies during Initial Public Offering (IPO) or secondary offerings. Its main purpose is to provide stability and control to a company’s stock price after the offering. By leveraging the Greenshoe option, underwriters are enabled to stabilize the price of shares as they can buy back shares at the offer price, thus preventing the share price from dropping below the offer price. This method ensures that the market does not become oversaturated with shares, which could lead to a significant drop in share prices.Moreover, the Greenshoe option also facilitates the underwriting process as it provides an opportunity for underwriters to sell more shares than originally planned if the demand is strong, allowing companies to raise more capital. Normally, underwriters are allowed to sell an additional 15% of the company’s shares on top of what has been initially offered. This extra allotment of shares released in the market can help satisfy the excess demand, maintain the stability of share prices during the post-IPO period and contribute to the overall success of an offering.
Examples
1. Alibaba IPO – When Alibaba went public in the U.S. in 2014, it had a greenshoe option in its favour. The company raised nearly $22 billion through its initial offering, but the underwriters exercised their greenshoe option to purchase additional shares, raising the total to about $25 billion. This made it the largest IPO in history at that time.2. Facebook IPO – Facebook Inc. made use of the greenshoe option in its 2012 Initial Public Offering (IPO). With the execution of this option, the overall size of Facebook’s IPO increased from its original amount by an additional 15%. Despite a somewhat shaky start, this allowed Facebook to raise even more capital and provided extra securities for high demand from investors.3. General Motors IPO – General Motors applied the greenshoe option back in 2010 when the auto giant went public again following its bankruptcy during the 2008 financial crisis. GM’s underwriters helped the firm sell almost 31.25 million additional shares, raising an extra $2.37 billion. Overall, this made the IPO one of the largest in history, raising about $20.1 billion.
Frequently Asked Questions(FAQ)
What is a Greenshoe Option?
A Greenshoe Option is a clause included in an underwriting agreement that allows the underwriting syndicate to buy up to an additional 15% of company shares at the offering price for a certain period after the offering.
Why is it called the Greenshoe Option?
The term Greenshoe Option originated from the name of the Green Shoe Manufacturing Company, now known as Stride Rite Corporation. It was the first company to implement this type of option in an underwriting agreement.
What is the main purpose of a Greenshoe Option?
The main purpose of a Greenshoe Option is to stabilize the price of a security post its initial public offering (IPO) or secondary market offering.
How does a Greenshoe Option benefit the underwriter?
The Greenshoe Option benefits the underwriter by allowing them to sell more shares than originally planned if demand is high, or to buy back shares to support the price if the initial public offering does not go as well as expected.
Is a Greenshoe Option mandatory for all IPOs?
No, a Greenshoe option is not mandatory for all IPOs. It is entirely up to the issuer and the underwriting syndicate to decide whether or not to include it in the underwriting agreement.
How does a Greenshoe Option affect investors?
For investors, a Greenshoe Option can reduce the risk of volatility in the share price immediately after an IPO or secondary offering. It can provide more stability and potentially increase confidence in the stock.
How long does a Greenshoe option last?
Typically, a Greenshoe option can be exercised by the underwriters within 30 days from the date of the initial offering.
What is the difference between a Greenshoe Option and a Reverse Greenshoe Option?
A Greenshoe Option allows the underwriters to purchase additional shares in case of excess demand. In contrast, a Reverse Greenshoe Option allows the underwriters to buy shares in the open market and then return them to the issuer to prevent an oversupply of shares.
Related Finance Terms
- Initial Public Offering (IPO)
- Over-allotment
- Securities and Exchange Commission (SEC)
- Underwriting
- Share Dilution
Sources for More Information
