What Is A 'Greenshoe Option': Underwriting Agreement Underwriter
What Is A 'Greenshoe Option': Underwriting Agreement Underwriter
What Is A 'Greenshoe Option': Underwriting Agreement Underwriter
Price Stabilization
The underwriter works as a liaison (like a dealer), finding buyers for the
shares that their client is offering.
A price for the shares is determined by the sellers (company owners and
directors) and the buyers (underwriters and clients).
When the price is determined, the shares are ready to publicly trade. The
underwriter has to ensure that these shares do not trade below the offering
price.
If the underwriter finds there is a possibility of the shares trading below the
offering price, they can exercise the greenshoe option.
For example, if a company decides to publicly sell 1 million shares, the underwriters
(or "stabilizers") can exercise their greenshoe option and sell 1.15 million shares.
When the shares are priced and can be publicly traded, the underwriters can buy
back 15% of the shares. This enables underwriters to stabilize fluctuating share
prices by increasing or decreasing the supply of shares according to initial
public demand.
If the market price of the shares exceeds the offering price that is originally set
before trading, the underwriters could not buy back the shares without incurring a
loss. This is where the greenshoe option is useful: it allows the underwriters to buy
back the shares at the offering price, thus protecting them from the loss.
A famous example of a greenshoe option at work is the Facebook Inc. IPO in 2012.
In that case, the underwriters had agreed to sell 421 million shares of the company
at $38. The issue proved to be very popular and they exercised their greenshoe
option, effectively selling 484 million shares on the market.
In 2014, underwriters exercised their greenshoe option during the IPO for Alibaba
Group Holding Ltd., making it the largest IPO in history at the time, at $25 billion.