Greenshoe
Encyclopedia
A greenshoe 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 the only SEC-permitted means for an underwriter to stabilize the price of a new issue post-pricing. 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.
A company intends to sell 1 million shares of its stock in a public offering through an investment banking firm (or group of firms which are known as the syndicate
) whom the company has chosen to be the offering's underwriter(s). When the stock offering is the first time the stock is available for public trading, it is called an IPO (initial public offering). When there is already an established market and the company is simply selling more of their non-publicly traded stock, it is called a follow-on
offering.
The underwriters function as the broker of these shares and find buyers among their clients. A price for the shares is determined by agreement between the company and the buyers. One responsibility of the lead underwriter in a successful offering is to help ensure that once the shares begin to publicly trade, they do not trade below the offering price.
When a public offering trades below its offering price, the offering is said to have "broke issue" or "broke syndicate bid". This creates the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares. To manage this possible situation, the underwriter initially oversells ("shorts") to their clients the offering by an additional 15% of the offering size. In this example the underwriter would sell 1.15 million shares of stock to its clients. When the offering is priced and those 1.15 million shares are "effective" (become eligible for public trading), the underwriter is able to support and stabilize the offering price bid (which is also known as the "syndicate bid") by buying back the extra 15% of shares (150,000 shares in this example) in the market at or below the offer price. They can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their 15% oversell short.
If the offering is successful and in strong demand such that the price of the stock immediately goes up and stays above the offering price, then the underwriter has oversold the offering by 15% and is now technically short those shares. If they were to go into the open market to buy back that 15% of shares, the underwriter would be buying back those shares at a higher price than it sold them at, and would incur a loss on the transaction.
This is where the over-allotment (greenshoe) option comes into play: the company grants the underwriters the option to take from the company up to 15% more shares than the original offering size at the offering price. If the underwriters were able to buy back all of its oversold shares at the offering price in support of the deal, they would not need to exercise any of the greenshoe. But if they were only able to buy back some of the shares before the stock went higher, then they would exercise a partial greenshoe for the rest of the shares. If they were not able to buy back any of the oversold 15% of shares at the offering price ("syndicate bid") because the stock immediately went and stayed up, then they would be able to completely cover their 15% short position by exercising the full greenshoe.
Prospectus (finance)
In finance, a prospectus is a document that describes a financial security for potential buyers. A prospectus commonly provides investors with material information about mutual funds, stocks, bonds and other investments, such as a description of the company's business, financial statements,...
), gives underwriters
Underwriting
Underwriting refers to the process that a large financial service provider uses to assess the eligibility of a customer to receive their products . The name derives from the Lloyd's of London insurance market...
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 the only SEC-permitted means for an underwriter to stabilize the price of a new issue post-pricing. 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
Stride Rite Corporation
The Stride Rite Corporation is a marketer of children's footwear in the United States and is a major marketer of athletic and casual footwear for children and adults...
, to permit underwriters to use this practice in its offering.
How it works
The mechanism by which the greenshoe option works to provide stability and liquidity to a public offering is described in the following example:A company intends to sell 1 million shares of its stock in a public offering through an investment banking firm (or group of firms which are known as the syndicate
Syndicate
A syndicate is a self-organizing group of individuals, companies or entities formed to transact some specific business, or to promote a common interest or in the case of criminals, to engage in organized crime...
) whom the company has chosen to be the offering's underwriter(s). When the stock offering is the first time the stock is available for public trading, it is called an IPO (initial public offering). When there is already an established market and the company is simply selling more of their non-publicly traded stock, it is called a follow-on
Secondary Market Offering
A secondary market offering, according to the U.S. Financial Industry Regulatory Authority , is a registered offering of a large block of a security that has been previously issued to the public. The blocks being offered may have been held by large investors or institutions, and proceeds of the...
offering.
The underwriters function as the broker of these shares and find buyers among their clients. A price for the shares is determined by agreement between the company and the buyers. One responsibility of the lead underwriter in a successful offering is to help ensure that once the shares begin to publicly trade, they do not trade below the offering price.
When a public offering trades below its offering price, the offering is said to have "broke issue" or "broke syndicate bid". This creates the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares. To manage this possible situation, the underwriter initially oversells ("shorts") to their clients the offering by an additional 15% of the offering size. In this example the underwriter would sell 1.15 million shares of stock to its clients. When the offering is priced and those 1.15 million shares are "effective" (become eligible for public trading), the underwriter is able to support and stabilize the offering price bid (which is also known as the "syndicate bid") by buying back the extra 15% of shares (150,000 shares in this example) in the market at or below the offer price. They can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their 15% oversell short.
If the offering is successful and in strong demand such that the price of the stock immediately goes up and stays above the offering price, then the underwriter has oversold the offering by 15% and is now technically short those shares. If they were to go into the open market to buy back that 15% of shares, the underwriter would be buying back those shares at a higher price than it sold them at, and would incur a loss on the transaction.
This is where the over-allotment (greenshoe) option comes into play: the company grants the underwriters the option to take from the company up to 15% more shares than the original offering size at the offering price. If the underwriters were able to buy back all of its oversold shares at the offering price in support of the deal, they would not need to exercise any of the greenshoe. But if they were only able to buy back some of the shares before the stock went higher, then they would exercise a partial greenshoe for the rest of the shares. If they were not able to buy back any of the oversold 15% of shares at the offering price ("syndicate bid") because the stock immediately went and stayed up, then they would be able to completely cover their 15% short position by exercising the full greenshoe.