What better way to kick start this journey than this journal’s first name. Greenshoe.
You might be wondering why this name was chosen. Frankly speaking, the Greenshoe Option or more professionally known as the over-allotment option / stabilization option, is the purest form of legalized market manipulation in modern finance. Her elegance was hence deemed worthy of this journal’s name.
So, why do I rave about her elegance?
Quoting investopedia, ‘Greenshoe Options: An IPO’s best friend’, the Greenshoe gives the underwriter the right to sell to investors more shares than originally planned by the issuer. The devil is in the word underwriter. Why isn’t the right given to the issuer?
Mainstream knowledge deems the Greenshoe as a necessary tool in the after-market performance of a stock. Oh boy, it definitely is necessary.
- The utilization of the Greenshoe Option is determined pre-lodging of the prospectus.
- In Singapore, over-allotment is permitted up to 20% of the offering. Let’s say the company decides to have a 15% Greenshoe Option
- Post listing, should the share price rise, the underwriter exercises this option to over-allot the shares and buy the extra 15% of shares sold to investors at the IPO price, ultimately resulting in an enlarged capital raise of 115%
- Post listing, should the share price falls, the underwriter exercises this option to stabilize the share price by buying in the open market up to the pre-determined (15%) of shares. If the stabilization option is utilized in full, i.e buying back 15% of shares in the open market, the quantum the issuer realizes would henceforth be only 100%
Well, let’s get on to her elegance.
In the occasion that the share price rises post IPO, it also means that 115% of the initial offering was sold. Key point here is that the fees that accrue to an underwriter would be equal to (IPO fee %) x (no. of shares underwritten). It therefore makes perfect sense for the underwriter to yearn for a larger offering.
On the flip side, in the occasion that the share price falls post IPO, underwriters buy back shares from the open market. You might be thinking, the amount underwritten by the underwriters would not be as large as the previous scenario, hence a reduction in fees. That’s accurate, but only to a certain extent. Underwriters buy the fallen shares on the open market at a discount and have the right to return the shares back to the issuer at IPO price. What happens to the spread then? 100% of it enters the underwriters pockets. Voila! There you go. Does this create a conflict of interest then? Obviously. But guess what, it is highly encouraged by regulators and issuers are demanding for such an option at IPO.
Elegant isn’t it. So the next time you see a prospectus with an over allotment option, just think about the fees that goes into the underwriters pocket. An IPO’s Best Friend?, definitely a Banker’s Best Friend.
GS
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