Diesel

NIVESHAK 31
CLASSROOM
FinFunda
of the
Month
GREEN SHOE OPTION
Saket hawelia
IIM Shillong
Cover Classroom Story
Sir, whenever we talk of the process of
listing of shares, more often than not
we end up discussing what underwriting
of shares is. And an in-depth study of
underwriting often leads us to Green Shoe Option.
What exactly is a Green Shoe Option?
Many a times, during the process of
underwriting, there exists a clause that the
underwriters are permitted to allot shares
over and above what was intended to be
allotted by the issuing Company. Legally, it can be
referred to as the option given to the underwriters
to ensure over allotment, in case there is an excess
demand for the proposed issue.
Green Shoe Option is usually exercised by the
company in order to ensure a price stability and
avoid the price fluctuations that may exist because
of demand exceeding the supply.
Sir, in that case why would the company
give this option to the investment banker
as an increased allotment of shares may
lead to dilution of control?
The entire objective of exercising the Green
Shoe Option is to stabilise the pricing of
the shares. So, when after the listing of the
Company, the investors try to book their
profit by selling the shares. As a result of this, there
is an excessive supply of shares, leading to a sharp
fall in the prices. I such a case, the Company shall
intervene by exercising the Green Shoe Option and
purchase the shares to create a “pseudo demand”
leading to price stability.
But Sir, why would the company over allot
the shares? Can you please explain how
this option actually functions using an
example?
Ok, let us assume that a Company ABC
Ltd is planning to issue 200,000 shares.
It exercises the Green House Option
and actually issues 230,000 shares. It is
important to note here that in this case,
the Company does not really issue the “new shares”
but provides the additional shares to the public
by borrowing the same from the promoters of the
company.
Now, after the Company has been listed, it might
so happen that the shares are being traded in the
stock exchange at a price lower than the issue price.
In such a case, the underwriter or the “stabilising
agent” intervenes and starts purchasing the shares
to put a halt on the falling share prices. The shares so
bought are then handed over to the original owners
or the promoters of the Company.
Sir, what if the shares are not being traded
at a price lower than the issue price?
In that case, the company does not
purchase the shares at all for the time
being and waits for an appropriate time to
enter the market.
The concepts are pretty clear now, Sir. But
one last question. Why is the Green Shoe
Option so called?
The name “Green Shoe” Option was coined
in 1919, when Green Shoe Manufacturing
Company, now known as the Stride Rite
Corporation became the first company ever
to exercise this option of over allotment.
Thank you Sir. This explanation makes
things very clear.
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