Greenshoe option also referred to as over-allotment option was termed Greenshoe option as Green Shoe Manufacturing Company for the first time implemented the greenshoe provision in their IPO underwriting agreement. The option is regulated by Securities and Exchange Board of India (SEBI).
The greenshoe or over-allotment option is a tool utilized by issuers of IPOs to maintain price stability such that the price of the share post listing on the exchanges do not fall above or below the offer price. In general scenario, issuer of the IPO has to issue as many shares as detailed in the offer document. However, with the greenshoe option, issuer has the option to issue additional shares. The arrangement allows over-allotment of shares to the maximum of 15% of the issue size.
To ascertain price stability post listing of the IPO on the exchange during the 30-day stabilization period, underwriters of the IPO issue (leading investment banks) purchase equity shares in the event if the share price plummets below offer price or vice-versa.
Let us understand greenshoe option with an example :
In case a company X floats an IPO of issue size of 5 million shares with 10% greenshoe option. And in case it witnesses surge in demand, underwriters to the issue can issue additional 5lakh shares.
Implication of exercise of greenshoe option for investor
The exercise of greenshoe option increases the probability of shares being issued to the investor. Also, the option is likely to result in price stability of the stock post listing on the exchange in comparison to the overall stock market outlook.