Green shoe Option (GSO).
This is a post listing price stabilizing mechanism, by which the company intends to ensure that the shares price on the Stock exchanges does not fall below the issue price.
The term “Green shoe option” derived its name from the company in US which excercised this mechanism for the first time.
The Securities and Exchange Board of India (SEBI) guidelines permit exercise of the greenshoe option by a company making a public issue. A pre-issue contract is required to be entered into for this purpose with an existing shareholder — often one of the promoters. The guide lines requires the promoter to lend his shares to be used for price stabilisation to be carried out by a stabilising agent on behalf of the company.
The stabilizing agent can be one of the lead book runner and the stabilization period can be for a period of maximum period of 30 days from the date of allotment of shares.
The company then goes on to make allotment, including over allotment, to the extent it has exercised the greenshoe option, which term incidentally has its origin in the name of a company that for the first time exercised such an option in the US. The proceeds of the public issue to the extent it relates to such over-subscription permitted by the greenshoe option is, however, kept in an escrow account to be used in the price stabilisation exercise (explained clearly how these funds are to be used).
Green shoe option is to be exercised in an IPO. The SEBI guideline requires the promoters of the company to lend some shares (the maximum upper limit being 15% of the total number of shares being issued through IPO) to the stabilizing agent whose duty is to monitor the post listing price of the companies share in the stock exchange.
How Green shoe option works?
The entire process of a greenshoe option works on over-allotment of shares. Say, for instance, that a company is planning to issue only 100,000 shares, but in order to utilize the greenshoe option, it actually issues 115,000 shares, in which case the over-allotment would be 15,000 shares. However the point that the company does not issue any new shares for the over-allotment should be noted.
The 15,000 shares used for the over-allotment are actually borrowed from the promoters with whom the stabilizing agent enters into a separate agreement. For the subscribers of a public issue, it makes no difference whether the company is allotting shares out of the freshly issued 100,000 shares or from the 15,000 shares borrowed from the promoters. Once allotted, a share is just a share for an investor.
For the company, however, the situation is totally different. The money received from the over-allotment is required to be kept in a separate bank account (which is GSO bank Account) .
The main job of the stabilizing agent begins only after trading in the share starts at the stock exchanges.
In case the shares are trading at a price lower than the offer price, the stabilizing agent starts buying the shares by using the money lying in the separate bank account. In this manner, by buying the shares when others are selling, the stabilizing agent tries to put the brakes on falling prices. The shares so bought from the market are handed over to the promoters from whom they were borrowed.
In case the newly listed shares start trading at a price higher than the offer price, the stabilizing agent does not buy any shares.
Then how would he return the shares? At this point, the company by exercising the greenshoe option issues new shares to the stabilizing agent, which are in turn handed over to the promoters from whom the shares were borrowed.