Green Shoe Option
What it is:
A green shoe option is a clause contained in the underwriting agreement of an initial public offering (IPO). Also known as an over-allotment provision, it allows the underwriting syndicate to buy up to an additional 15% of the shares at the offering price if public demand for the shares exceeds expectations and the stock trades above its offering price.
How it works/Example:
As the underwriter has the ability to increase supply if demand is higher than expected, a greenshoe option can create price stability during an .
Some agreements do not include greenshoe options in their underwriting agreements. This is usually the case when the issuer wants to fund a specific project at a pre-determined cost and does not want to be responsible for more capital than it originally sought.
Why it matters:
A green shoe option can create greater profits for both the issuer and the underwriting company if demand is greater than expected. It also facilitates price stability.
The Green Shoe Company, now called Stride Rite Corp., was the first issuer to allow the over-allotment option to its underwriters, hence the name.