Page 122 - Initial Public Offering - An Introduction to IPO on Wall Street

However, during this duration of time, as restrictions against price manipulation are lifted, the
underwriter is allowed to trade and control the price of the issue. The following are some of
the strategies used by underwriters to perform IPO stabilization:

Overallotment or Greenshoe Option

An over-allotment option also referred to as a greenshoe option, is an option given to
underwriters during an IPO to issue more shares. Underwriters can sell 15% additional shares
than the number of shares they initially agreed to sell, but the opportunity must be utilized
within thirty days of the offer being made.
The IPO underwriting contract between the issuing business and the underwriters includes the
precise details of the allocation. If the market for the shares exceeds the anticipated demand
and the selling price is substantially greater than the offer price, the underwriters, typically
brokerage firms or investment banks, can utilize the over-allotment option.

An over-allotment opportunity is very popular because it is one of the few risk-free, SEC-
approved ways for an underwriter to control the stock price. In an IPO, businesses will often
not permit a greenshoe option if they have a clear target for the IPO returns and want to avoid
raising more cash than required.

Reasons for Overallotment/Greenshoe

The following are some of the reasons an underwriter may choose to utilize the overallotment
or greenshoe option:

Demand for the Business’s Shares

The underwriters for an organization may utilize the greenshoe option to gain from the demand
for the business’s shares. This happens more when a well-known business releases an IPO
because as compared to lesser-known businesses, far more investors are likely to consider
investments in well-known organizations.
For instance, when Facebook conducted its IPO in 2012, because of the business’s success and
future growth potential, its shares were in great demand. Oversubscription of the shares of the
business enabled it to collect additional money to fulfill the demand via over-allotment.

Price Stabilization

Overallotment may also be utilized as a price-stabilization mechanism when demand for the
shares of a business rises or decreases. The underwriters take losses when the prices of the
shares fall beneath the offer price, and they may purchase the stock at a lower price to stabilize
the price.

The repurchase of the stock decreases the supply of shares, contributing to a rise in the price of
the shares. For instance, if an organization chooses to conduct an IPO of two million shares, the
underwriters will utilize the 15 percent overallotment option to offer a total of 2.3 million
shares.

If the securities are sold publicly, the underwriters will then be able to buy back the additional
0.3 million shares. By regulating the supply of the shares as per their demand, helps stabilize
varying, unstable share prices.

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