Green Shoe Option

The Green Shoe Option, also known as an over-allotment option, is a provision in an initial public offering (IPO) or follow-on public offering (FPO) that allows the underwriters (merchant bankers) to sell additional shares beyond the original issue size in case of excess demand. It is a stabilisation mechanism designed to maintain post-listing price stability and prevent excessive volatility in a newly issued security.
The term originates from the Green Shoe Manufacturing Company (now Stride Rite Corporation), which was the first company to include such an option in its 1919 public offering in the United States. The practice has since become an internationally accepted method of price stabilisation in public offerings.

Concept and Definition

The Green Shoe Option allows the issuing company to authorise underwriters to sell up to 15% more shares than originally planned. This over-allotment helps stabilise the share price in the aftermarket (post-listing) by managing excess demand and supply fluctuations.
If the stock price rises above the issue price after listing, underwriters exercise the option by allocating additional shares (up to the authorised limit) to meet investor demand. Conversely, if the stock price falls below the issue price, underwriters can buy back shares from the open market to support the price.
Hence, the Green Shoe Option acts as a price stabilisation tool, ensuring an orderly market for the newly listed security.

Mechanism of the Green Shoe Option

The Green Shoe Option operates through a structured process, managed by the stabilising agent, usually the lead merchant banker or book-running lead manager (BRLM).
The general mechanism involves the following steps:

1. Initial Issue and Over-Allotment:
   • The company files for an IPO with a Green Shoe Option clause.
   • The underwriters are permitted to over-allot up to 15% of the original issue size to investors during the subscription period.
2. Creation of the Green Shoe Account:
   • To cover the over-allotment, the issuer allots extra shares (15%) to the stabilising agent, who holds them in a separate “Green Shoe Account.”
3. Post-Listing Price Monitoring:
   • After listing, the stabilising agent monitors the market price of the shares for a defined stabilisation period (usually 30 days).
   • If the share price falls below the issue price, the stabilising agent buys back shares from the market using the funds collected from over-allotment sales.
4. Settlement:
   • If the price remains stable or rises above the issue price, the agent returns the excess shares to the issuer or promoters.
   • If the price falls, the repurchased shares are used to repay investors or adjust the over-allotted position.

Through this process, the Green Shoe Option prevents a steep fall in share prices after listing and instils investor confidence in the new issue.

Illustration

Suppose a company issues 10 million shares in an IPO at ₹100 per share. The underwriters have a Green Shoe Option for an additional 15%, i.e., 1.5 million shares.

• If the issue is oversubscribed and the stock price rises after listing, the underwriters exercise the option to sell the extra 1.5 million shares to meet investor demand.
• If the stock price falls below ₹100, the stabilising agent buys back shares from the open market to stabilise the price, using the proceeds from the over-allotment.

This stabilisation activity typically lasts for 30 days after the listing date.

Objectives of the Green Shoe Option

The Green Shoe Option serves multiple purposes in primary market operations:

• Price Stabilisation: Prevents excessive volatility in post-listing prices.
• Investor Confidence: Enhances trust among investors by reducing the risk of sharp price declines.
• Liquidity Support: Ensures adequate liquidity in the early trading days.
• Efficient Price Discovery: Facilitates smooth market functioning and fair valuation.
• Market Reputation: Strengthens the credibility of the issuing company and underwriters.

Regulatory Framework in India

In India, the Green Shoe Option is governed by the Securities and Exchange Board of India (SEBI) under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations).
Key provisions include:

• The option can be used for public issues of equity shares.
• The maximum over-allotment allowed is 15% of the issue size.
• A stabilising agent (SA)—usually the lead book-running manager—is appointed to manage the Green Shoe mechanism.
• The SA must enter into an agreement with the issuer and disclose the option details in the prospectus.
• The stabilisation period shall not exceed 30 calendar days from the date of allotment.
• The SA must maintain detailed records of market transactions, buybacks, and price movements during the stabilisation period.

SEBI introduced this mechanism to enhance investor protection and strengthen post-listing market stability for new issuances.

Advantages of the Green Shoe Option

For Issuers:

• Helps maintain a positive perception of the company post-listing.
• Reduces the risk of price manipulation and speculative selling.

For Underwriters:

• Provides a tool to manage market demand and supply effectively.
• Limits their exposure to losses in volatile market conditions.

For Investors:

• Protects investors from sharp price declines in newly listed shares.
• Builds confidence in participating in IPOs, knowing there is price support.

Disadvantages and Limitations

Despite its benefits, the Green Shoe Option has certain limitations:

• Temporary Effect: Price stabilisation is short-lived and limited to the stabilisation period.
• Market Perception: May create artificial demand if misused by underwriters.
• Complex Administration: Requires strict compliance, continuous monitoring, and detailed reporting.
• Limited Applicability: Only applicable to certain categories of public issues and not to all securities offerings.

Comparison with Other Stabilisation Mechanisms

Global Practices

Globally, the Green Shoe Option is widely used and recognised by major regulatory bodies such as the U.S. Securities and Exchange Commission (SEC), the Financial Conduct Authority (FCA) in the United Kingdom, and similar agencies in the European Union and Asia.
In the United States, Rule 104 of Regulation M governs stabilisation activities, including the Green Shoe Option, ensuring transparency and fair market practices.

Notable Examples in India

Several high-profile Indian IPOs have incorporated the Green Shoe Option for stabilisation, such as:

• Coal India Limited (2010)
• Reliance Power Limited (2008)
• ICICI Prudential Life Insurance (2016)
• Life Insurance Corporation of India (2022)

Significance in Capital Markets

The Green Shoe Option plays a crucial role in fostering market confidence, stabilising post-issue performance, and ensuring orderly price discovery. By protecting both issuers and investors from market volatility, it contributes to the credibility and efficiency of primary market operations.
It also symbolises a mature capital market structure where risk management and investor protection are integral to public offerings.