greenshoe

Greenshoe refers to a financial mechanism used in initial public offerings (IPOs) and some follow-on offerings. It is an over-allotment option granted to underwriters, allowing them to issue up to a specified number of additional shares beyond the original offering size, typically up to 15% of the base amount. The option helps underwriters manage demand and facilitates orderly pricing by enlarging the offering if investor demand is strong.

The option is usually exercisable for a limited period after the offering, frequently about 30 days. When exercised, the issuer issues additional shares to meet over-allotments, and these extra shares are allocated to investors who subscribed beyond the initial allotment. The greenshoe also enables price stabilization: underwriters may engage in stabilizing transactions, such as buying shares in the open market at or near the offering price, to support the price if trading is volatile.

Origin and name: the term greenshoe originates from a provision associated with the Green Shoe Manufacturing Company in a landmark U.S. securities case. The practice was adopted to provide underwriters with a flexible tool to support both the issuance process and aftermarket trading. Today, most IPOs include a greenshoe option as part of the underwriting agreement, and the specifics (such as the percentage and exercise period) can vary by offering.

Impact and considerations: the greenshoe can reduce the risk of undersubscription and help stabilize initial trading, but it results in potential dilution if new shares are issued. Its use is governed by securities regulations and disclosure requirements, and it is most effective when market demand is strong and orderly trading is achievable.