Decoding ‘Green Shoe’ option

Origin – ‘Green Shoe’ clause eponymously derived its name from ‘Green Shoe Manufacturing Company’ (GSMC). GSMC is a subsidiary of ‘Wolverine World Wide’ (WWW), incumbent. WWW is a footwear behemoth trading in New York Stock Exchange (NYSE).

Modus-Operandi Green shoe option entails excess issue of stocks with a ceiling not exceeding 15% of the original issue size. (15% may vary depending on localised regulations). For instance, A ltd proposes an issue of 1000 shares at INR 100. A ltd approaches a underwriter for the fund raising process. The under writer (say U Ltd)  buys the shares of A Ltd at INR 98 (2% discount). Shares with U ltd are transferred to the public for a consideration of Rs 110 per unit. Owing to exuberant demand for the stocks,  the shares of A Ltd get listed at 50% premium. In such cases, the work / pricing mechanism adopted by the underwriter goes for a toss. A notional loss as in the case of alleged 2G spectrum scandal is recognised. To put it simply, the shares have been under priced.  A green shoe option gains significance in such a circumstance, providing a recourse for the underwriter to recoup for the notional losses. A green shoe option entails a underwriter to  buy (from A Ltd) & sell up to 15% of the original count, i.e 150 shares here at a premium / profit, in addition the original issue.

Price-Stabilisation Strategy:  In case of over-subscription, the listing price skyrocket. On green-shoe option being exercised, additional shares are being pumped into circulation thereby palliating price volatility. On the contrary, a circumstance of under-subscription is also plausible. In such circumstances, the underwriter may adopt a long position (currently, buying at lesser cost in anticipation of future rise in prices) and purchases A ltd stocks from the market, thereby invigorating demand and prices, fixing price volatility. Albeit, green shoe option remains untapped in such cases. Ergo, Green Shoe option is an effective tool to mitigate price volatility after initial listing.

Instances where green-shoe option would have fructified:  IPO (Intial public offering) by IRCTC is the epitome to understand the necessity for a green shoe option. IRCTC share was priced at Rs 325 apiece over IPO. On its maiden day at the bourse, the price was hovering about 650 range. Market analysts widely hinted that IRCTC scrips were conservatively priced. An target INR 645 crore issue fetched a whooping INR 72,000 crores (112 times over subscribed). The Indian government could have achieved its disinvestment target of INR 1 Lakh crore substantially, had the pricing been not so conservative.  Had the green shoe option been in place, IRCTC could have garnered a better price for its shares, on exercising the option. Even now, listed companies have an offer-for-sale option to dilute their stake in the secondary market, at prevailing trading prices.

Indeed, its high time for companies to ponder about green shoe option for IPOs  impending…

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me @adithyaarunachalam@Gmail.com

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