24 July 2009
Green Shoe option, also known as the over-allotment provision. It gets its name from the Green Shoe company, which was the first company to allow such an option.It is an option which helps the Companiues in stabilizing the share prices after an IPO.
Procedure Whenever a company files for an IPO, it decides a day for listing on the stock exchange. On this day, the stock starts trading on the exchange. There are chances that the stock is listed at a price lower than the issue price, which has been happening with companies that are getting listed recently. There might be many reasons behind this like low valuation of the company, speculation, weakening market etc. To reduce the effect of such forces, SEBI included this option in the Indian Capital Markets. Most important point to note is that this option can only be used in case of an IPO and not for subsequent issues.
In order to utilize this option, the company has to appoint one of the lead managers as the Stabilizing agent (SA). As the name suggests, this Stabilizing agent is responsible for stabilizing the prices, once the stock gets listed at the stock exchange. As obvious as it may seem, the SA has to interfere only when the prices fall below the issue price. For this purpose, the SA enters into an agreement with the promoters, who in-turn lend their shares to the SA. Generally the promoter with the maximum shares is approached. These shares should not be more than 15% of the total issue size.
This agreement has to be mentioned in the DRHP (Draft Red Herring Prospectus) and the final prospectus. SA, after taking these shares, includes them with the shares under the IPO, thereby increasing the number of shares available to public. As such no discretion is maintained between borrowed shares and the fresh shares. The only difference maintained is that the money raised from selling the borrowed shares (of the promoters) is kept in a separate bank account, generally referred as the GSO bank account.
When the shares are listed at a price quite lower than the issue price, the SA buys some shares from the market using the money from the GSO bank account. The SA can buy the shares within 30 days starting from the listing date. With the help of these operations, the SA tries to stabilize the share prices. Shares when bought are returned back to promoters. It is the responsibility of the SA to decide the time of buying the shares, the quantity and the price. The entire idea behind this mechanism is that by putting excess shares in the market, the factors that skew the prices can be controlled. It is also possible that the share prices rise above the listing price; in that case the SA does not buy any shares. In order to return the shares to the lenders (promoters), the company issues new set of shares equal to that borrowed by the SA; therefore compensating the lenders for the shares.
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