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What is a green shoe?
An option allowing the issuer to increase the size of the offering
The green shoe, also referred to as over-allotment option, is an option which, during the placement of a company�s shares for the purpose of admission to Stock Exchange listing, offers the issuer the opportunity to increase the size of the offering so as to adequately satisfy the demand for shares on the part of investors.
Historically, the term �green shoe� (also written �greenshoe�) comes from the American company Green Shoe Corporation, which first introduced this technique at the time of its flotation. The existence and potential exercise of a green shoe (and the so-called over-allotment, which we shall talk about further on) must be expressly mentioned in the prospectus, in order to guarantee investors transparency regarding the offer mechanism.
The option, which normally has a duration of 30 days, is usually granted by the company�s shareholders, who declare their willingness to increase the number of shares put up for sale, thereby reducing their own shareholding. Less frequently, the shares concerned with the green shoe derive from a special capital increase which can be carried out in the event that the option is exercised.
The green shoe option is generally associated with the over-allotment mechanism, namely the short selling within the scope of the placement of a certain quantity of shares, usually equal to the amount of the green shoe in question. The shares forming the object of the over-allotment are placed by the lead managers with the institutional investors subscribing the shares concerned with the offering.
The exercise of the green shoe � if necessary � is not decided by the issuer, but by the placement syndicate managers. The option is exercised if the demand for shares on the market during such period exceeds the offering and therefore the price of the share tends to rise above the subscription price. The green shoe therefore depends on an adequate development of the offering: in such conditions the placement syndicate managers can in fact use the shares obtained from the issuer by exercising the option to cover the short sale made through the over-allotment.
If then the IPO[1]is successful and the shares are appreciated by investors, the members of the placement syndicate will ask for the green shoe to be exercised, the company will place a higher number of shares and the issuer�s equity structure will change accordingly, increasing the number of shares on the market and, consequently, the security�s free float. From this standpoint, the exercise of the green shoe represents an additional way of remunerating the placers, since the proceeds from the operation depend on the overall number of shares placed on the market.
On the other hand, if the share drops in price with respect to the placement, the shares needed to �cover� the over-allotment will be purchased on the market by the placement syndicate members (thus realising a trading profit, the shares of the over-allotment having been sold during the placement at the offer price and repurchased on the market at a lower price). In these circumstances the green shoe and over-allotment mechanism therefore serve to stabilise the price of the shares during the first few days of listing. In case of low demand the placers will purchase shares to cover the over-allotment, and such purchases may help to avoid excessive depreciation.
Usually the quantity of shares reserved for the green shoe does not exceed 15% of the global offering. This threshold is not set at regulatory level, but is common practice. Although the placers should seek to achieve the largest possible �slice� with a view to pocketing handsome capital gains in case of share appreciation, a percentage higher than 15% might not be favourably received on the market since it would imply the placement on the market of a quantity of shares in excess of actual demand, penalising the overall result of the transaction.