Green shoe like the adjacent picture is not a type or color of a shoe, but is a smart option which at times helps the companies in stabilizing their share prices after the IPO. This can be used just when the company gets listed in the stock exchange.
Green shoe option is nothing but allocating more shares than that mentioned in the issue, with an upper cap of 15% of the issue size. This helps in preventing the stock from the speculative forces, thereby keeping it close to the issue price. Point to note is that this is not a sure shot solution for removing the speculative forces, but is just an option that a company can use and reduce such effects. The entire procedure is mentioned below.
Whenever a company files for an IPO, it decides a day for listing on the stock exchange. On this day, the stock starts trading on the exchange. There are chances that the stock is listed at a price lower than the issue price, which has been happening with companies that are getting listed recently. There might be many reasons behind this like low valuation of the company, speculation, weakening market etc. To reduce the effect of such forces, SEBI included this option in the Indian Capital Markets. Most important point to note is that this option can only be used in case of an IPO and not for subsequent issues.
In order to utilize this option, the company has to appoint one of the lead managers as the IPO Stabilizing Agent (SA). As the name suggests, this Stabilizing agent is responsible for stabilizing the prices, once the stock gets listed at the stock exchange. As obvious as it may seem, the SA has to interfere only when the prices fall below the issue price.
For this purpose, the SA enters into an agreement with the promoters, who in-turn lend their shares to the SA. Generally the promoter with the maximum shares is approached. These shares should not be more than 15% of the total issue size. This agreement has to be mentioned in the DRHP (Draft RHP), RHP (Red Herring Prospectus) and the final prospectus.
IPO Stabilizing Agent, after taking these shares, includes them with the shares under the IPO, thereby increasing the number of shares available to public. As such no discretion is maintained between borrowed shares and the fresh shares. The only difference maintained is that the money raised from selling the borrowed shares (of the promoters) is kept in a separate bank account, generally referred as the GSO bank account.
When the shares are listed at a price quite lower than the issue price, the SA buys some shares from the market using the money from the GSO bank account. The SA can buy the shares within 30 days starting from the listing date. With the help of these operations, the SA tries to stabilize the share prices. Shares when bought are returned back to promoters. It is the responsibility of the SA to decide the time of buying the shares, the quantity and the price. The entire idea behind this mechanism is that by putting excess shares in the market, the factors that skew the prices can be controlled.
It is also possible that the share prices rise above the listing price; in that case the SA does not buy any shares. In order to return the shares to the lenders (promoters), the company issues new set of shares equal to that borrowed by the SA; therefore compensating the lenders for the shares. Below mentioned is an example, which will make the above procedure clear.
Suppose the company has filed an IPO to issue 1,00,000 shares with a Green shoe option of 10,000 shares (10% of the total issue). Therefore issuing a total of 1,10,000 shares, with a face value of Rs. 10 each. Once the issue is subscribed, all the shares are allotted to the applicants. The following two cases may arise after the stock is listed on the stock exchange.
- Case 1: Share Price falls below the issue price – In such a case, the SA will buy the shares, at its discretion, from the market to stabilize the price levels. This again leads to two sub-cases, which are as given below.
- Sub-case 1: SA doesn’t buy all the borrowed shares – It is possible that the SA doesn’t buy all the shares that it borrowed from the promoters. In such a case, the bought shares are returned back to the promoters. The company issues further fresh shares, equal to the number that are still to be given back to the promoters, and returns them to the promoter. Suppose the SA bought 2500 shares out of the total 10,000 borrowed shares. In that case, the company issues 7500 (10000-2500) shares to the promoters. Therefore the total shares issued by the company are 107500 (1,00,000 under the issue and 7500 under the green shoe option).
- Sub-case 2: SA buys back all the shares – This case is very simple, as all the borrowed shares are bought from the market and are returned back to the promoters. Therefore, the total shares issued by the company are 1,00,000 (under the issue).
- Case 2: Share price rises above the issue price – In such a case, the option is not exercised and thus no shares are bought back from the market. After the stabilization period (generally of 30 days) is over, the company issues fresh shares for the promoters. Therefore, the total shares issued are 1,10,000.
This option has a major benefit of reducing the overall risk for the company while going for an IPO. It also gives buying power to the underwriter, without the risk of having to buy stock if the price rises. Further, the option keeps the price stable, benefitting both the company and the investors.