Green Shoe Option
Green Shoe Option refers to a provision contained in an underwriting agreement of the Initial Public Offering (IPO) that provides a right to the underwriter to sell more number of shares to the investors than what were planned initially by the issuing company.
Green Shoe Option is also known by the name of over-allotment provision where underwriter can issue in the tune of 15% additional shares to the investors (based on demand) at the given offer price.
When the public demand exceeds the supply and expectations of the market and stock is trading at premium to its offer price, underwriter can utilize this option (right).
Green Shoe Option is a very effective way to smoothen out price fluctuation in the stock when the demand exceeds supply.
The term Green Shoe Option was derived from the company by the same name that exercised this option for the first time.
However, many of the IPO agreements don’t prefer to include Green Shoe Option in their underwriting agreements usually. This is when the issuer of shares doesn’t want to be responsible for more capital than actually required by it in the beginning and only wants to fund the project at specified cost.
Importance of Green Shoe Options
This is useful in creating greater profits for both the issuer and underwriter (when demand exceeds supply) and helps in controlling price fluctuation.