Page 123 - Initial Public Offering - An Introduction to IPO on Wall Street

Price Exceeds the Offer Price

Rising demand for the shares of a business will increase share prices to a value above the price
of the offer. In such a case, since doing so will lead to a loss, the underwriters will not buy back
the stock at the existing market price.

At this stage, without taking losses, the underwriters can utilize their greenshoe option to
purchase additional shares at the initial offer price. The disparity between the price of the offer
and the actual market price tends to cover any loss suffered when the shares traded below the
price of the offer.
Overallotment Option Example

421 million Facebook shares were sold to the underwriters at a share price of $38 when the
company conducted its IPO in 2012; the underwriters that purchased Facebook’s shares
included a group of investment banks entrusted with making sure that the holdings are sold and
the money generated is sent to the organization.

They will get 1.1 percent of the sale in the exchange. The main underwriter was Morgan
Stanley. The starting price was $42, 05 when the Facebook stock began trading, an increase of
11 percent over the IPO price. The stock quickly became unstable and the price of the stock
decreased to $38. The underwriters sold a total of 484 million Facebook shares for $388
million.

This implies that by selling an extra 63 million shares, the underwriters utilized an allotment
option. Press statements suggested that the underwriters moved in and bought additional shares
to stabilize rates. To cover any loss suffered in stabilizing the rates, the underwriters could buy
back the extra 63 million shares at $38 per share.

SEC Regulations on Overallotment

The Securities and Exchange Commission (SEC) permits underwriters to participate in
transparent short sales in a share offering. Typically, when they expect a price decline,
underwriters utilize short selling, but the practice opens them to increases in price as a risk.

In the U.S, underwriters short sell the offering and buy it in the aftermarket to stabilize prices.
Although selling short triggers downward pressure on the price of the stock, this strategy may
stimulate a more sustainable offering that eventually leads to a more profitable offering of
stocks.

In 2008, however, the SEC abolished the practice of what it called "abusive naked short
selling.” The reason was that some underwriters participated in naked short selling during IPO
activities as a way to manipulate stock prices. The practice generated a clear impression that a
business’s shares were moving very aggressively when only a small number of market
participants were exploiting the changes in prices.

Full, Partial, and Reverse Greenshoe

Underwriters can select either a partial or full greenshoe for use. In a partial greenshoe, the
underwriter purchases back from the market just half of the shares until the price goes up. A
full greenshoe is exactly how it sounds: the underwriter utilizes the full opportunity to purchase
additional shares at the initial offering price.

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