Green Shoe Option

Greenshoe Option Group Members: Harsh Singh Jayant Mundhra Mridul Aggarwal Mudit Rajgarhia Abhinav Bhandari Atul Saraswat

What is it ?? A

provision in an underwriting agreement that gives the underwriter the right to sell investors more shares than originally planned by the issuer.

This

would normally be done if the demand for a security issue proves higher than expected.

Mainly

practiced in US and European Markets

History ØGreen Shoe Manufacturing Company (now called Stride Rite Corporation), founded in 1919. ØFirst company to implement Green Shoe Option in the underwriting agreement.

Greenshoe provision üAllows underwritter to purchase an additional 15% of the issue from the issuer. üAllows the issue to be oversubscribed reffered as over allotment option. üProvides price stability to a security issue as the underwriter has the ability to increase supply and smooth out price fluctuations.

1. The underwriter works as a liaison (dealer), finding buyers for the shares that their client is offering. 3. Price for the shares is determined by the sellers (company owners and directors) and the buyers (underwriters and clients). 5. When the price is determined, the shares are ready to publicly trade. The underwriter has to ensure that these shares do not trade below the offering price.

How does it work ?  If

a company decides to publicly sell 1 million shares, the underwriters can exercise their green shoe option and sell 1.15 million shares.

 When

the shares are priced and can be publicly traded, the underwriters can buy back 15% of the shares.

 With

Green Shoe Option provision underwriters have the power to buy back the shares at the same original offered price, even if the market price is more. Thereby

 In

opposite case if IPO trades below the offering price (referred as break issue) to stabilize share prices, the underwriters may again buy back the shares.

 This

enables underwriters to stabilize fluctuating share prices by increasing or decreasing the supply of shares according to initial public demand.

How regular greenshoe option works  Underwriter

has sold 115% of shares (15%

more). The IPO price is set to be $10.  If

mrkt price falls to $8, underwriter does not use the greenshoe. It buys back some or all the shares at $8 in the market. Buying a large bloc of shares stabilizes the price.

 If

the price grows to $12, the underwriter exercises the option, buying shares from the issuer at $10 and selling at $12 per share.

Full and Partial Greenshoes

The number of shares the underwriter buys back determines if they will exercise a partial greenshoe or a full greenshoe. Ø A partial greenshoe is when underwriters are only able to buy back some shares before the price of the shares increases. Ø A full greenshoe occurs when they are unable to buy back any shares before the price goes higher.

Example ØExxon initially offered 161.9m shs. Subscriptions for 475.5m shs. Used Green Shoe for additional 84.58m. ØTata Steel was able to raise $150 million by selling additional securities through the Green Shoe option.