RESEARCH PAPER – LAW OF SECURITIES

THE GREEN SHOE OPTION PERSPECTIVE

Submitted by

S. Shiny Sree

BC0150023

Research paper Submitted to

Mr. MOHAMMAD AZAAD

Professor of Law

TAMIL NADU NATIONAL LAW UNIVERSITY

(A State University established by Act No. 9 of 2012)

NavalurKuttapattu, Srirangam (TK), Tiruchirappalli – 620027.

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 DECLARATION

I, S. Shiny Sree, Register Number BC0150023, hereby declare that this Research Paper work

entitled “THE GREEN SHOE OPTION PERSPECTIVE” has been originally carried out

by me under the guidance and supervision of Mr. Mohammad Azaad, Professor of Law,

Tamil Nadu National Law University, Tiruchirappalli - 620027. This work has not been

submitted either in whole or in part of any Degree / Diploma at any University.

Place: Tiruchirappalli

Date: 10.07.2020 (S. Shiny Sree)

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 TABLE OF CONTENTS

ABSTRACT……………………………………………………………………………..4

CHAPTER I – INTRODUCTION……………………………………………………..6

CHAPTER II- EVOLUTION OF GREEN SHOE OPTION………………………..7

a) Meaning ……………………………………………………………………….....8
b) Types of Green Shoe Option ……………………………………………………8
c) Need for Green Shoe Option…………………………………………………….8

CHAPTER III- SEBI‟s JURISDICTION

a) In issuance of public issue of shares…………………………………………….10

b) Sebi‟s regulation of IPO………………………………………………………….11
c) DIP Guidelines …………………………………………………………………..12

CHAPTER IV- INITIAL PUBLIC OFFERING …………………………………….14

a) Mechanism of initial public offering…………………………………………….14

b) Over-allotment option……………………………………………………………15

CHAPTER V- GREEN SHOE OPTION IN INDIA

a) Guidelines for exercising green shoe option……………………………………..16

b) How green shoe option works……………………………………………………16
c) Role of the stabilising agent……………………………………………………...17
d) Rationale behind green shoe option……………………………………………...17
e) Reasons for indifference towards green shoe option…………………………….18

CHAPTER VI- GREEN SHOE OPTION IN OTHER COUNTRIES

a) Green shoe option in USA……………………………………………………….20

b) Green Shoe option in UK………………………………………………………...21
c) Green Shoe option in Germany…………………………………………………..21
d) Country Analysis of GSO: USA and India……………………………………….22

CHAPTER VII- EMPIRICAL RESEARCH

a) Findings from the study…………………………………………………………..23

b) Suggestions……………………………………………………………………….23
c) Criticisms…………………………………………………………………………24

CHAPTER VIII- CONCLUSION……………………………………………………...25

ANNEXURES …………………………………………………………………………...26

BIBLIOGRPAHY………………………………………………………………………..30

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 THE GREEN SHOE OPTION PERSPECTIVE

ABSTRACT

The Green Shoe Option can be seen as an “Over allotment option”. SEBI introduced this
option with a view to boost investor‟s confidence by arresting the speculative force, which
works immediately after listing and thus result in short term volatility in post listing price. It
ensures price stability. A Green Shoe Option means an option of allocating shares in excess
of the shares floated in the public issue and operating a post-issue price stabilizing
mechanism for a period not exceeding 30 days. This permission has been granted to a
company to be exercised with caution through a stabilizing agent. As per this arrangement, an
issue could be over allotted to the extent of a maximum of 15% of the issue size. From an
investor‟s point of view, an issue with the green shoe option provides more probability of
getting shares allotted to him. It also ensures that the post-listing price will be stable than the
market price. This study aims to understand the concept & importance of Green Shoe Options
in India, SEBI Guidelines & analysing Green Shoe Option as a Price Stabilization
mechanism.. The green shoe has the ability to reduce risk for the company issuing the shares.
It allows the underwriter to have buying power in order to cover their short position when a
stock price falls, without the risk of having to buy stock if the price rises. In return, this helps
keep the share price stable, which positively affects both the issuers and investors. This paper
analyses its working and importance in comparison with other jurisdictions.

Keywords: Green Shoe Option, India, IPO, Primary market, price stabilisation

RESEARCH OBJECTIVE

The main objective of the paper is to understand the concept and importance of Green Shoe
Option as prescribed in the SEBI Guidelines and its comparison among India, UK and USA.

RESEARCH QUESTIONS

1. Whether Green Shoe Option is a price stabilising mechanism?

2. Whether Green Shoe Option is an effective tool for IPO in companies?
3. How it is differentiated in India, UK and USA?

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 4. What are findings of the survey and does the knowledge of green shoe option must be
imparted to investors more?

SCOPE OF THE TOPIC

The topic is related to investor protection scheme under Module 1, but since it‟s a regulation
made under SEBI (Disclosure and Investor Protection) Guidelines, 2000, it falls under the
various regulations of SEBI like book building, underwriting etc. Therefore it is covered
under Module 2 of the Syllabus,

RESEARCH METHODOLOGY

The methodology for this paper is an empirical research. An online survey was conducted
within various individual investors. Various primary and secondary sources were analysed for
effective researching.

REVIEW OF LITERATURE

1. Reena Aggarwal, in the article on “Stabilization Activities by Underwriters after

Initial Public Offerings”, revealed that more than half of IPOs, a short position of an
average 10.75 percent of shares offered is covered in 22 transactions over 16.6 days in
the aftermarket, resulting in a loss of 3.61 percent of underwriting fees. Underwriters
manage price support activities by using a combination of aftermarket short covering,
penalty bids, and the selective use of the over allotment option.
2. Vasant Sivaraman, Shweta Singh & Jyoti Abrol, in their “Shoe Option: Can It
Mitigate Mispricing?” attempted to examine if the GSO, which has been introduced
in India as a tool for book build issues since Aug 2003 (subsequently modified in May
2004), can play an effective role in the area of fair pricing of IPOs.
3. Ravi Kapoor, Senior vice-president, DSP Merrill Lynch, said, “The amount raised in
the form of GSO will be used to stabilise the price of the stock post-listing, raising
comfort levels of investors (that price would be stabilized post listing) and
encouraging increased participation from investors.”

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CHAPTER - I

INTRODUCTION

Green shoe option is nothing but a stabilization mechanism for post listing price for newly
issued shares. It provides the option of allotting equity shares in excess of the equity shares
offered in the public issue. It is a clause contained in the underwriting agreement of an initial
public offering that allows underwriters to buy up to an additional 15% of company shares at
the offering price. This option was recognized by Security Exchange Board of India through
its new guidelines on 14th August, 2003. The said price stabilizing mechanism is laid down
in Regulation 45 of SEBI (ICDR) regulations, 2009. A GSO provides the option of allotting
equity shares in excess of the equity shares offered in the public issue as a post-listing price
stabilising mechanism1. Investors purchase shares of organizations in IPO in the trust that the
shares would exchange in the secondary market at a cost higher than the first offering cost.
Investors would surely be restless if the cost of the shares in the secondary market is
profoundly unstable in the period quickly taking after the posting date. Such instability is
adverse to investor certainty, to the picture of the issue company and the issue managers, and
to capital markets in large. This requires some kind of value adjustment instrument or
mechanism. The goal of this instrument is to console investors, particularly little investor
who are known as Retail Individual Investor (RIIs), that they would have a way out course
amid the initial 30 days after the posting of shares (called the GSO window period) at a value
near the issue cost, because of the value settling movement of the trader banks. The issuer
likewise profits by this component, as confident investor certainty will bring about more
offers at better costs.

This study aims to understand the concept & importance of Green Shoe Options in India,
SEBI Guidelines & analysing Green Shoe Option as a Price Stabilization mechanism. This
study is based on survey of individual investors. The green shoe has the ability to reduce risk
for the company issuing the shares. It allows the underwriter to have buying power in order to
cover their short position when a stock price falls, without the risk of having to buy stock if
the price rises. In return, this helps keep the share price stable, which positively affects both
the issuers and investors.

1
Regulation 2(1) (o) of the SEBI (ICDR) Regulations, 2009.

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CHAPTER-II

EVOLUTION OF GREENSHOE OPTION

The mere fact that the significant part of the equity underwriting process is named after
colourful footwear adds a mystery or a different dimension of the process. The term
"greenshoe" came from the Green Shoe Manufacturing Company (now called Stride Rite
Corporation) which was founded in 1919. It was the first company to implement the green-
shoe clause into their underwriting agreement.

In the company prospectus, the legal term for the green shoe option is over-allotment option,
because in addition to the shares originally offered, shares are set aside for underwriters.2
This type of option is the only means permitted by the US Securities and Exchange
Commission (SEC) for an underwriter to legally stabilise the price of a new issue after the
offering price has been determined. The SEC introduced this option to enhance the efficiency
and competitiveness of the fund raising process for IPOs.

The Securities and Exchange Board of India (SEBI) has introduced Green Shoe Option
(GSO) on 12th August 2003, in order to bring the Indian Primary Markets on par with global
markets such as US, Canada and others where over 90 percent of the primary issues is
through the Book-Building route having the GSO.3”

One of the major beneficiaries of the GSO happens to be the investor as this option helps to
preserve his capital as buying of excess shares limits panic selling in the market, as and when
the stock gets listed on the market.”

SEBI introduced this option with a view to boost investor‟s confidence by arresting the
speculative force, which works immediately after listing and thus result in short term
volatility in post listing price. It ensures price stability.”

Alibaba Group Holding Ltd. became the largest IPO by generating $25 billion using this
option on 19th September 2014. It enables the bankers to take the amount of money raised by
the company and selling shareholders to $25 billion from $21.8 billion.4”

2
A.K.Mazumdar, & Dr. G.K. Kapoor, Company Law and Practice, A concise commentary on companies act
2013 216 (Taxman).
3
Prashanta Athma & Anitha Rani, Green Shoe Option in India: An Analysis, Vol 1 Issue 3 (2012), APJEM.
4
Telis Demos, Alibaba IPO Biggest in History as Bankers Exercise 'Green Shoe' Option, W. S. J, SEPT 21.
2014.

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 a) Meaning

A Green Shoe Option means an option of allocating shares in excess of the shares floated in
the public issue and operating a post-issue price stabilizing mechanism for a period not
exceeding 30 days. This permission has been granted to a company to be exercised with
caution through a stabilizing agent. As per this arrangement, an issue could be over allotted to
the extent of a maximum of 15% of the issue size.

b) Types of Green Shoe Option

There are three types of GSO viz., Full, Partial and Reverse Green shoes. The number of
shares the underwriter buys back determines if they will exercise a partial Green shoe or a
full green shoe.

A Partial Green shoe is when the underwriters are only able to buy back some shares before
the price of the shares increases.

A Full Green shoe occurs when they are unable to buy back any shares before the price goes
higher. At this point, the underwriter needs to exercise the full option and buy at the offering
price. The option can be exercised any time throughout the first 30 days of IPO trading.

A variant of the Green Shoe Option practised in international capital markets is the Reverse
Green Shoe Option. Though the end result of both Green Shoe and Reverse Green Shoe
Options is to achieve the price stabilisation, both mechanisms function differently. Under the
Reverse Option, in the event that there is a fall in the share prices during the stabilisation
period, the stabilising agent would procure shares from the open market at the depressed
prices, and sell them back to the issuer at the (higher) issue price. Procurement of large
blocks of shares from the open market while exercising Reverse Green Shoe would assist in
stabilising the falling share prices. However, in light of the Company Law provisions in
India that prohibit a company from owning its own shares, applicability of Reverse Green
Shoe mechanism in an Indian context is somewhat curtailed

c) The Need for Green Shoe Option

Public Offerings may supply a large number of securities into a market, as a result of which,
there is a risk that the price of the securities will be highly volatile immediately after the
commencement of the offering. Price volatility is likely to be even greater in the case of an

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Initial Public Offering (IPO) because there is no established Secondary Market for the
securities.

The purpose of an issuer and/or a selling security holder in providing an underwriter with an
over-allotment is to allow the underwriter to stabilize the after-market for the issuer's
securities in the period immediately after the public offering begins. By allowing an
underwriter to obtain additional securities covering an over-allotment and to sell these
securities to the public, an underwriter can maintain a balance between the demand for an
issuer's securities and the supply of securities available to satisfy market demand.

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CHAPTER- III

SEBI‟S JURISDICTION

a) In Issuance of Public Issue of Shares

Section 24 of the Companies Act 20135 defines SEBI‟s jurisdiction over listed companies and
companies which intend to get their shares listed on any stock exchange with respect to issue
and transfer of securities and non-payment of dividend. SEBI regulates the market offerings
by exercising powers under sections 11(1), 11(2A), 11(3), 11(4), 11A, 11B and 11D of the
SEBI Act, 1992.”

SEBI‟s jurisdiction with respect to companies going for a public issue arise from the
provisions of Regulation 6(1) SEBI (ICDR) Regulations6 that require Issuer to file a draft
offer documents through the Lead Merchant Bankers, 30 days prior to filing the offer
document with the Registrar of Companies, in case of a public or a rights issue where the
aggregate value of the specified securities issued is fifty lakh rupees or more.”

The Honourable Supreme Court in the case of Sahara India Real Estate Corporation Ltd.
V.SEBI7 highlighted certain critical aspects of SEBI‟s jurisdiction under Section 55A of the
erstwhile Companies Act 1956 read with section 67(3). It was held that any offer of securities
made to more than 49 persons would amount to a public offer and hence would come under
the regulatory purview of SEBI. Such offers have to conform to the SEBI (ICDR)
Regulations, 2009 in the matters of disclosures and to Section 60B of the Companies Act,
1956 with respect to filing of the prospectus with the Registrar of Companies.”

Further it was held that even in the case where the securities are privately placed without any
intention on the part of the issuer to list the shares on the stock exchange, the honourable
court held that when an offer is made to more than 49 persons, it shall be considered as a
public offer and the requirement to list the securities would naturally apply irrespective of the
intention of the issuer.”

With regards to the powers of SEBI in the matter of regulating the issuance and transfer of
securities the High Court of Delhi in the case of Kinshuk Krishna Sinha V.SEBI8 held that

5
Corresponding section 55A inserted by the Companies (Amendment)Act, 2000
6
Previously, this was provided under Clause 1.4.(i) under the DIP guidelines, 2000
7
CIVIL APPEAL NO. 9813 OF 2011
8
W.P.(C) 7976 Of 2007 & Cm Appl No. 15084/07

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the powers of SEBI in the context of section 55A under the companies Act have to be
construed in the broadest sense and SEBI is empowered to take corrective and preventive
action by enquiring into the contents of the of prospectus when misstatements in the
prospectus is alleged. The court also held the DIP guidelines issued by SEBI statutory in
nature.”

b) In Regulation of Initial Public Offering

SEBI Act, 1992 as originally enacted did not confer explicit powers to SEBI to act against
issuers with respect to public offerings. The regulatory and supervisory power over
companies was vested with the Ministry of Corporate Affairs. In the absence of a clear
mandate to take actions against issuers, SEBI regulated the market for public offerings by
issuing directions under Section 11B in the interests of the investors.”

The Securities Laws (Amendment) Act in 1995 extended SEBI‟s jurisdiction over companies
issuing capital and transfer of securities in addition to all intermediaries and persons
associated with the securities market by incorporating Section 11A. The amendment of 1995
also empowered SEBI to appoint adjudication officers to adjudicate violations and levy
penalties. It provided for the establishment of Securities Appellate Tribunals (SATs) to hear
appeals against the orders of the adjudication officers. Section 11A of the Act empowers
SEBI to prohibit any company from issuing any offer document including the prospectus,
soliciting money from the public for the issue of securities and specify conditions under
which such offer document can be issued.9”

As an initial public offering is by an unlisted company, there is no information to the

investors with regarding to track record of the company‟s performance in the past. To guide
the investors to determine the credibility of the issue, stringent provisions have been drafted
by SEBI. These restrictions are in the nature of eligibility norms for Issuers intending to
access the market. These norms have been revised regularly to balance between protecting
the investors while enabling a smooth process of issuance of securities by the corporates.
SEBI‟s regulation of the primary market is also based on the recommendations of the Primary
Market Advisory Committee (PMAC).”

9
https://www.amttraining.com/online/technical-updates/greenshoe-option-fundamentals/ last accessed on
08/07/2020/

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 c) The Disclosure and Investor Protection

With the onset of liberalization and the repeal of the office of CCI, Issuers were able to
access the market without the approval of the Central Government. To protect the interest of
the investors, SEBI issued the guidelines for Disclosure and Investor Protection (DIP),
1992.10

Under the guidelines, Issuers were required to make adequate disclosures so that investors are
enabled to take an informed opinion regarding the issue. This marked the shift in the market
design for IPOs from a merit based control to a disclosure based regulation Under the DIP
guidelines; a new company having no track record was allowed to issue shares only at par.
However a company set up by promoters with a 5 year record of operating history was free to
price their issue. While SEBI ushered in the era of free pricing, the pricing formula under
CCI was retained initially to ensure the reasonableness of pricing. Certain critical disclosures
with respect to promoters past history, information relating to deployment of funds were
required to be disclosed under the DIP guidelines to enable investors to check the credibility
of the issue. The onus of verifying disclosures in the offer documents, advertisements was
entrusted to Merchant Bankers by notifying the SEBI (Merchant Banking) Regulation, 1992.
Issues were monitored on the basis of pre issue and post issue reports filed by Merchant
Bankers.”

While SEBI was vetting the offer documents since 1991, it was made mandatory under the
DIP guidelines, 1992. Primary markers during this period recorded a phenomenal growth
with 1236 offer documents filed intending to raise a capital of Rs 27195 crores showing the
eagerness of the issuers to take benefit of the liberalized norms.11 However owing to weak
response from investors, a large number of issues devolved on Underwriters. For this purpose
underwriting was made mandatory and underwriting activities were brought under the
purview of SEBI with the drafting of the SEBI (Underwriting) Regulation, 1993.”

During the year 1993-94, majority of issues (32%) were at premium and the Indian public
were the largest allottees (Rs8496.31 crores) compared to FIIs and domestic institutions in
the public offerings.12 While under CCI, allotment was on weighted basis in favour of
applications for smaller amounts, SEBI ushered in the system of proportional allotment in

10
Vide order GL/IP No.1/SEBI/PMD, 92-93 DATED 11.06.1992
11
SEBI Annual Report 1992-93
12
SEBI Annual Report 1993-94

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IPOs to check the problem of multiple applications.13 Reservations on competitive basis and
firm allotments to Foreign Institutional Investors, Domestic Institutions and Scheduled Banks
were allowed to foster foreign investment in the Capital market.”

Consequently by 1994-95 the share of the Indian public in the primary market declined as
only 48.71% of total amount raised from public issues were offered to the public and the rest
was reserved for Institutional investors.14”

d) DIP Guidelines vs. ICDR Regulations - Impact on Green Shoe Option

Until September 2009, the regulatory framework governing capital market issuances in India
was the SEBI (Disclosure and Investor Protection) Guidelines, 2000 (DIP Guidelines). With
the notification of the ICDR Regulations on 3rd September, 2009, several clauses of the DIP
Guidelines were amended to reflect current market dynamics. While some of the provisions
underwent a complete overhaul, some other provisions were only modified to provide greater
clarity, removing redundancies, etc. Chapter 8A of the DIP Guidelines which dealt with
Green Shoe Option was adopted to provide post listing price stability to IPOs; the mechanism
of GSO was introduced to be exercised to the extent of 15% of the issue size. Almost in its
entirety, except for a minor operational modification – any surplus fund remaining in the
escrow account would need to be transferred to the Investor Protection and Education Fund,
as against the Investor Protection Fund of the stock exchanges. It required Merchant Bankers
acting as „Stabilizing agent „to ensure post listing price stability for 30 days after the listing of
securities.”

13
Circular no.SMD/SED/Cir/93/PMD/7311 dated 3.12.1993
14
SEBI Annual Report 1994-95

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CHAPTER-1V

INITIAL PUBLIC OFFERING

An initial public offering (IPO) is essentially the birth of a company in its public form. It
changes many things about the way that management runs the firm and can present
opportunities and dangers for retail investors. IPOs are more common during bull markets
and the recent rally in stocks may provide another fertile environment for these corporate
events.” An IPO is the first sale of a stock or share by a company to the public. Companies
offering an IPO are sometimes new, young companies, or companies which have been
around for many years and have finally decided to go public.

Before investing in an IPO, we go through the offer document of the company to know
more about it. A listed company is legally bound to abide by commitments made in the
document. Besides providing information about the company's competitive strengths,
industry regulation, corporate structure, main objects, subsidiary details, risk factors, etc,
the offer document also mentions a technical word called “Green shoe option”.

a) Mechanism of Initial Public Offering

To keep the share price under control, the underwriter oversells or shorts up to 15% more
shares than initially offered by the company. For instance, if company ABC decides to sell 10
million shares, the underwriters may exercise their green shoe option and sell 11.5 million
shares. When the shares are actually listed in the market, the underwriters can buy back 15%
of the shares. If the market price of the shares exceeds the offer price, the underwriters
exercise the green shoe option to buy back 15% of the shares at the offer price, thus
protecting them from the loss. Similarly, if the shares trade below the offer price, it may
create a wrong impression in the minds of the investors and they may sell the shares they
have bought or stop buying more from the market. In such a scenario, to stabilise share
prices, the underwriters exercise their option and buy back the shares at the offer price and
return the shares to the issuer. In the entire process the company has no role to play and any
gains or losses arising out of the green shoe option belong to the underwriters. To conclude,
from investor‟s point of view those companies which have green shoe option in their IPO

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process are considered to be good because they have a built-in price stabilising mechanism
which will ensure the prices will not go below its offer price.”

b) Over – allotment option

The green shoe option allows companies to intervene in the market to stabilise share prices
during the 30-day stabilisation period immediately after listing. This involves purchase of
equity shares from the market by the company-appointed agent in case the shares fall below
issue price.

The green shoe option is exercised by a company making a public issue. The issuer company
uses green shoe option during IPO to ensure that the shares price on the stock exchanges
does not fall below the issue price after issue of shares.

Green shoe is a kind of option which is primarily used at the time of IPO or listing of any
stock to ensure a successful opening price. Any company when decides to go public
generally prefers the IPO route, which it does with the help of big investment bankers also
called underwriters. These underwriters are responsible for making the public issue
successful and find the buyers for company‟s shares. They are paid a certain amount of
commission to do this work.

Green shoe option is a clause contained in the underwriting agreement of an IPO. The green
shoe option is also often referred to 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.

From an investor's perspective, an issue with green shoe option provides more probability of
getting shares and also that post listing price may show relatively more stability as compared
to market.

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CHAPTER - V

GREEN SHOE OPTION IN INDIA

Green shoe options or over-allotment options were introduced by the Securities and
Exchange Board of India (SEBI) in 2003 to stabilise the aftermarket price of shares issued in
IPOs.

a) Guidelines for exercising green shoe option

The guidelines require the promoter to lend his shares (not more than 15% of issue size)
which is to be used for price stabilisation to be carried out by a stabilising agent (normally
merchant banker or book runner) on behalf of the company.

The stabilisation period can be up to 30 days from the date of allotment of shares to bring
stability in post listing pricing of shares.

After making the decision to go public, the company appoints underwriters to find the buyers
for their issue. Sometimes, these underwriters also help the corporate in determining the
issue price and

But with the turbulent times prevailing in the market place, it is however quite possible that
the IPO undersubscribed and trades below its issue price.

This is where these underwriters invoke the green shoe option to stabilise the issue.

b) How green shoe option works

As said earlier, the entire process of a green shoe option works on over-allotment of shares.
For instance, a company plans to issue 1 lakh shares, but to use the green shoe option; it
actually issues 1.15 lakh shares, in which case the over-allotment would be 15,000 shares.
Please note, the company does not issue any new shares for the over-allotment.

The 15,000 shares used for the over-allotment are actually borrowed from the promoters
with whom the stabilising agent signs a separate agreement. For the subscribers of a public
issue, it makes no difference whether the company is allotting shares out of the freshly
issued 1 lakh shares or from the 15,000 shares borrowed from the promoters.

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Once allotted, a share is just a share for an investor. For the company, however, the situation
is totally different. The money received from the over-allotment is required to be kept in a
separate bank account (i.e. escrow account)

c) Role of the stabilising agent

The stabilising agent starts its process only after trading in the share starts at the stock
exchanges. A company desirous of availing this option, should in the resolution of the general
meeting authorizing the public issue, seek authorization also for the possibility of allotment of
further shares to the „Stabilizing Agent‟ (SA) at the end of the stabilization period.15”

In case the shares are trading at a price lower than the offer price, the stabilising agent starts
buying the shares by using the money lying in the separate bank account. In this manner, by
buying the shares when others are selling, the stabilising agent tries to put the brakes on
falling prices. The shares so bought from the market are handed over to the promoters from
whom they were borrowed. In case the newly listed shares start trading at a price higher than
the offer price, the stabilising agent does not buy any shares.

Green shoe option in action

It is very common for companies to offer the green shoe option in their underwriting
agreement. In 2009, most realty companies in India, who were planning to raise funds from
the primary market, had opted for green shoe option in their IPOs to stem volatility in share
prices following their listing on the exchanges.16

Companies such as Sahara Prime City, DB Realty, Lodha Developers and Ambience had
opted for the green shoe option, which helped them stabilise share prices in the event of
extreme volatility or prices moving below offer price.

d) Rationale behind Green Shoe Option

First, and importantly, the IPO price is a sacred thing. The company, investors and the lead
IPO underwriter all want to see the stock trade up in the after-market. When a stock trades
up in the aftermarket, everyone wins. However, when a stock price falls below the IPO price,
the IPO is considered broken, the company and investors are disappointed and the lead
15
The GSO process mentioned in this topic is in accordance with Regulation 45 of SEBI (ICDR) Regulation,
2009 as well as Chapter VIII (A) of SEBI (DIP) Guidelines, 2000.
16
Capital Market and Securities Law, ICSI 2015.

Page 17 of 30
underwriter suffers reputational damage (with the company, with institutions buying the IPO,
with future IPO clients, etc.). In addition, it is common for lawsuits to occur when a stock
falls below the IPO price in the first days of trading. For these reasons (and more), it is
customary for the lead underwriter to work to stabilize the market and keep the stock price
above the IPO price. This is called IPO price stabilization.17”

Public Offerings may supply a large number of securities into a market, as a result of which,
there is a risk that the price of the securities will be highly volatile immediately after the
commencement of the offering. Price volatility is likely to be even greater in the case of an
Initial Public Offering (IPO) because there is no established Secondary Market for the
securities. The purpose of an issuer and/or a selling security holder in providing an
underwriter with an over-allotment is to allow the underwriter to stabilize the after-market
for the issuer's securities in the period immediately after the public offering begins. By
allowing an underwriter to obtain additional securities covering an over-allotment and to sell
these securities to the public, an underwriter can maintain a balance between the demand for
an issuer's securities and the supply of securities available to satisfy market demand.”

One of the benefits of using the green shoe is its ability to reduce risk for the company
issuing the shares. It allows the underwriter to have buying power in order to cover their
short position when a stock price falls, without the risk of having to buy stock if the price
rises. In return, this helps keep the share price stable, which positively affects both the
issuers and investors. It is an Investor Protection measure especially for the small investors
during post-listing period. It helps in showing confidence in the IPO price, protecting the
reputation of merchant banks, enhancing liquidity in the aftermarket, and favouring preferred
clients.”

e) Reasons for Indifference towards Green Shoe Option:

1. Uncertainty about impact of GSOs

The GSOs facility was highly constrained by the limit of 15% over-allotment and the 30- day
stabilisation period. The general opinion was that there was no guarantee that the stabilisation
programme would in fact be successful.”

17
http://www.allenlatta.com/allens-blog/understanding-the-over-allotment-option-or-green-shoe-in-an-ipo /last
accessed on 08/07/2020/

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2. Interference with free play of market forces

The GSO would merely reinforce these free plays of market. Further, any aftermarket price
stabilisation would deprive “value investors” from purchasing shares from naïve investors
when the price falls in the immediate aftermarket.”

3. Unfair advantage for merchant banks

Merchant banks that are designated as stabilising agents get high fees for availing of the
GSOs. Such high fees for merchant banks were felt to be unjust as they face limited risk in
implementing GSOs.”

4. Unwillingness of merchant banks to accept additional responsibility

The issuer companies and merchant banks that we interacted with felt that the legal and
regulatory compliances were cumbersome, and that the consequent risks had increased
manifold. In this scenario, they were not prepared to take any additional responsibility for a
facility that was optional to begin with.”

5. Lack of incentives

According to the GSO regulations, merchant bankers are not allowed to earn a profit from the
aftermarket price stabilising activity. They will have to buy the stock if the price falls below
the offer price, but they are not allowed to sell even if the stock value goes up. Any profits
arising from the price stabilisation activity need to be transferred to the Investor Protection
and Education Fund (IPEF) established by the SEBI.”

6. Absence of market discipline

In a mature market, if the aftermarket price of the shares falls significantly, the investors
would hold the merchant banks responsible for the same. In such an event, the credibility of
the merchant banks would take a hit. This would adversely affect their chances of getting
further business because investors would keep away from the issues managed by them.
However, investors in India, especially the RIIs, appear to be indifferent to ascribing
responsibility. In the face of this lack of market discipline, merchant banks in India have no
reason to shirk the additional responsibilities associated with GSOs and talk about the lack of
incentives.”

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CHAPTER- VI

GREEN SHOW OPTION IN OTHER COUNTRIES

The over-allotment option is known by different names in different countries; for instance, in
the US, it is called the Green Shoe Option, in Germany it is known as the Over-Allotment
Arrangement (OAA), and in the U.K, it is known as the Market Stabilisation Measure.”

1. Green Shoe Option in the US:

In the US, it is very common for companies to include the GSO, officially known as the
overallotment option, for stabilising the aftermarket price. There are three kinds of
overallotment mechanisms prevalent in the US:”

(a) Pure Stabilisation: In the pure stabilisation mechanism, underwriters post a stabilising
bid to purchase shares at a price that does not exceed the offer price if the distribution of
shares is not complete. These stabilising bids are required to have a flag identifying them as
stabilization bids. Such a flag would send a clear signal to the market that the offering is
weak and that stabilisation is required, which appears to be one of the reasons why
underwriters avoid using pure stabilisation.”

(b) Aftermarket short covering bid: In an aftermarket short covering bid in the US, the
lead managers initially sell shares in excess of the original number offered, thereby taking a
short position prior to the offering. This short position may be covered or naked. Covered
and naked positions differ in the options available to the lead managers if the post-listing
market price of the share is higher than the issue price.”

In the case of a covered short position, if the post-listing market price of the share is higher
than the issue price, the lead manager does not buy the shares from the secondary market, as
this would result in a loss. Rather, the lead manager asks the issuer company to allot fresh
shares at the issue price. On the other hand, if the post-listing market price of the share is
lower than the issue price, the lead manager purchases the shares from the secondary market
to close out its short position, as this would result in a profit. There is no possibility of
incurring a loss in a covered short position. In the case of a naked short position, if the post-
listing market price of the share is higher than the issue price, the lead manager has no
alternative but to buy the shares from the secondary market, resulting in a loss. If, on the

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other hand, the post-listing market price of the share is lower than the issue price, the
underwriter purchases the shares from the secondary market, as it would result in a profit.”

(c) Penalty bid: A penalty bid mechanism involves imposing penalties on those syndicate
members whose customers sell shares in the days immediately after the listing of shares.
Syndicate members are brokers who receive a commission for getting their clients to bid for
the shares at the IPO. The penalty usually involves reclaiming the whole or a part of the
commission that was due to a syndicate member if his/her clients sold their shares
immediately after listing. The lead merchant banks, called managing underwriters, are
required to disclose the presence of penalty bids to the stock exchanges, and to maintain
records of their scope, duration, and enforcement18”

2. Green Shoe Option in the UK:

The Committee of European Securities Regulators (CESR) provides a broad framework of

GSO regime to be followed by its member states. The responsibility for GSOs lies with the
investments services firms, called stabilising managers. The possibility of stabilisation is
required to be disclosed in the prospectus, and stabilisation activity must be recorded and
disclosed in an appropriate manner (CESR (2002)).”

The GSO regime in the UK allows an issuer company to over-allot shares to the maximum
extent of 15%; the stabilising activity may be carried out for a maximum period of 30 days
after listing (the GSO window period). However, the regulations explicitly mandate only a
partial GSO, i.e., the stabilising agent can only buy the shares in the aftermarket at a price
lower than or equal to the issue price.19 Further, an explicit disclosure has to be made to the
effect that although a claim is made that stabilisation may be undertaken, there is no
assurance that it will in fact be undertaken, and that it may be stopped at any time20.”

3. Green Shoe Option in Germany

In Germany, the GSO, known as an Over-Allotment Arrangement (OAA), involves the

merchant banker borrowing shares from pre-issue shareholders or directly from the issuer
company. The merchant banker is required to return the shares within a fixed period of time,

18
SEC Rule M (100).
19
Article 9 of the Buy-back and Stabilisation Regulation
20
Supra 3

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usually one month. Any profit resulting from the price stabilisation activity can be retained
by the merchant banker.”

c) Country Analysis of Green Shoe Option: USA vs. India

USA uses the green shoe option very liberally and many companies use the green shoe option
for stabilizing the market price after listing. The US Securities and Exchange Commission
(SEC) define price stabilization as “…transactions for the purpose of preventing or retarding
a decline in the market price of a security to facilitate an offering.”

The window is only 14 days, while India follows a 30 day period. The Green Shoe option
was first introduced in USA, while it was introduced in India by SEBI in 2003.

In India, the overallotment option is allowed up to 15%, while in USA it is the maximum of a
20% overallotment option. Profit retention is allowed in USA, while it is not in India.

There are three kinds of over-allotment mechanisms prevalent in the US: (a) pure
stabilization; (b) aftermarket short covering bid; and (c) penalty bid In USA, it was found that
underwriters generally use a combination of aftermarket short covering bid and penalty bids,
along with a selective use of over-allotment option to support the price. Penalty bids are not
allowed in India.

GSO has been a success in USA, while in India it is still growing as the full potential of GSO
has not been unlocked due to lack of awareness among other criticisms.

Naked short selling, or naked shorting, is the practice of short-selling a tradable asset of any
kind without first borrowing the security or ensuring that the security can be borrowed, as is
conventionally done in a short sale. This is not allowed in India while it is widely allowed in
the US.

Thus, to bring India up to the global market level of USA in regard for GSOs, it should be
developed more and more awareness should be brought about India to give investors a better
advantage and companies a new outlook for IPOs. There should be slightly more freedom
regarding the overallotment option and changes should be made about the profit retention to
encourage GSO Usage as for the current scenario.

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CHAPTER- VII

EMPIRICAL STUDY ON GREENSHOE OPTION

a) Limitation of the Study:

 “The study is limited to Green Shoe Options in India only.”

 “Survey is limited to 20 people.”

b) Data Collection:

Primary Data – Online Survey of Individual Investors

c) Findings
 From the analysis only 50% of investors are strongly agree of awareness of stock
market, agree are 20% & strongly disagree are 0%.
 From findings 20% strongly agree of trading procedure in stock market, 30% agree &
10% strongly disagree
 As per analysis 10% strongly agree of awareness of portfolio management, agree are
20% & strongly disagree are 20%.
 From analysis only 20% are strongly agree of awareness of book building, 10% are
agree & 10% are strongly disagree.
 As per analysis 40% are interested in Regular investment, 30% are seasonal
investment & 30% in periodical investment.
 As per findings investor‟s transaction are 10% in 0-6 months, 5% in 12 months, 1-2
years 30% & 2 years & above 55%.
 According to survey the basis of investment for investors are track record 30%,
Present financial performance 20%, nature of business 10% & image of the
company 40%.
 From the opinion surveys of Green Shoe Option 0% are for strongly agree, 10% are
agree & 10% strongly disagree.”

d) Suggestions:
 GSO can be made mandatory in case of IPOs to benefit the Investors.
 GSO facility to be increased to 25% from 15% of over allotment.

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  The stabilization period can be increased to 45 days from 30 days, to successful
and to include all categories of investors.
 Nominal fees can be given to Merchant bankers appointed by company to carry
out transactions with code of conduct.
 Legal and regulatory complications can be reduced to give participation to all
categories of investors.
 GSO to be implemented in all countries to give best opportunity to all investors
worldwide.
 GSO in bearish market give opportunity to underwriters to buy more than 15% at
prices lower than the issue price from the market.
 As per findings only 50% are aware of stock market, for this SEBI has to give
advertisement in mass media not only focusing on some TV channels &
Newspapers or magazines it has to be there in every mass media every 10 minutes
to create awareness in the mind of investors to avoid their fear about stock market.
 Only 20% are strongly agree of procedure in stock market, for this SEBI has to
establish branches everywhere & brokers are to have network to reach to a variety
of investors towards stock exchange.
 10% of investors know about Portfolio management, it means investors are afraid
of stock exchange because of volatility of stock market, it has to overcome by
creating a channels of investors, it means if one investor invested in stock market,
he has to inform his friends the benefits and how to get return through
management
 0% investors known about this still its introduced in Aug 2003, awareness should
be created amongst the Companies, Merchant Bankers and Investors about the
GSO and its importance.
 50% of investors are invested in share market, it means they are not aware of
commodity & derivative market, for this SEBI has to give more scope for these
types of markets.”

e) Criticism of Green Shoe Option :

Green Shoe mechanism, despite its wide usage, is not without its share of criticism. To begin
with, the Green Shoe mechanism is certainly not a cure-all antidote for falling share prices.
While the stabilising agent acts as a ready buyer for the shares in the post listing period, for a

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company with weak fundamentals or for a badly priced IPO, sustained buying alone would
not be enough to send the share prices sky rocketing upwards to match the initial IPO price.
Secondly, the prescribed period for price support is rather limited at 30 days. For a savvy
cartel of market operators determined to push down the share price, the stabilisation period
would be a minor time pocket to weather out before making some serious play in the market.
Thirdly, the ICDR Regulations already prescribe a more robust mechanism for protection of
the small investor – the „safety net arrangement‟ mechanism covered in Regulation 44. Under
the safety net arrangement mechanism, an issuer company can appoint a third party who
would offer to purchase equity shares from original resident retail individual investors up to
one thousand equity shares for a maximum period of six months from date of issue. The
longer time frame covered under this mechanism, and the re-purchase guarantee given to the
small investors definitely provide a greater sense of comfort to the investing public.
However, the key impediment in adopting this option is finding a suitable third party who
would be willing to offer the commitment to shareholders. Despite the above shortcomings,
the Green Shoe mechanism has been widely used by issuer companies to provide share price
support to investors in their initial public offerings.

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CHAPTER-VIII

CONCLUSION

Based on the analysis of the aftermarket price performance of the companies that availed of
the GSO facility in their IPO programmes, it could be concluded that GSOs were not
effective in stabilising the prices in the period immediately following the listing date.
However, broad generalizations cannot be made due to the small size of the companies, both
in absolute terms and as a proportion of the companies making IPOs. Of the companies that
did not include the GSO facility in their IPO programmes, a disproportionately large number
of companies performed poorly. This led us to propose that GSOs be made mandatory;
merchant bankers would need to disclose their track record; and the IPO norms would have to
be tightened, especially for small issues.”

The price stabilization proves to be a blessing in disguise for the retail investors in case of
violent fluctuations in the share prices. Investors tend to give better pricing of offers with a
green shoe option or with price stabilization, as they are sure that in post-listing, the merchant
banker will guarantee price stability. The process also serves as a reassurance to the small or
rather the retail individual investors that they would have a safe exit route during the first 30
days after the listing of shares i.e. the green shoe option period. This exit would be definitely
at a price close to the issue price, due to the price stabilizing activity of the merchant banks.
This enhanced investor confidence will result in more bids from investors at better prices
which is the requirement for every company.”

From the analysis it is found that people aware of the stock market, but a lot of people doesn't
know the trading operations. Investors doesn‟t know different financial instruments and also
they don‟t know about the book building effectiveness and impact happening in the stock
market, from that they fail to take an advantage of profitable because of lack of awareness.
Almost all many of them are shown their keen to the investment in share market; it reveals
that taking advantage of Short term gain by investing more in share market which are static.
Investors also gave importance to goodwill of the company.”

GSO though introduced in 2003 and nearing a decade, still it is in infantry stage in India.
Very few companies have gone for GSO and reaped the benefit of price stabilization. It is
high time that awareness programs are conducted to educate the companies about the
importance of GSO.”

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ANNEXURES

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Page 28 of 30
Page 29 of 30
 BIBLIOGRAPHY

Acts:

1) SEBI (Disclosure and Investor Protection) Guidelines, 2000

2) Securities and Exchange Board of India Act, 1992
3) Securities Exchange Act, 1934

Books:

1) A.K MAZUMDAR & Dr. G.K. KAPOOR, Company Law & Practice, Taxmann
Publication Pvt. Ltd, New Delhi (2015)

Articles:

2) AGGARWAL, R. (2003). “Allocation of Initial Public Offerings and Flipping

Activity.” Journal of Financial Economics, 68(1), pp. 111–135.

3) Vasant Sivaraman, Shweta Singh & Jyoti Abrol, in their “Shoe Option: Can It
Mitigate Mispricing?” No.4 (Jan 2014)

4) CHRIS J. MUSCARELLA & JOHN W. PEAVY III, “Optimal Exercise of the

Over-Allotment Option in IPOs” Financial Analysts Journal Vol. 48, No. 3 (May -
Jun., 1992), pp. 76-81.

5) PRASHANTA ATHMA & ANITHA RANI, Green Shoe Option in India: An

Analysis, Vol 1 Issue 3 (2012), APJEM.

Websites:

1) https://www.sebi.gov.in/last accessed on 08/07/2020/

2) https://www.investopedia.com/last accessed on 09/07/2020
3) https://www.amttraining.com/online/technical-updates/greenshoe-option-
fundamentals/ last accessed on 08/07/2020/

4) http://www.allenlatta.com/allens-blog/understanding-the-over-allotment-option-or-
green-shoe-in-an-ipo/last accessed on 08/07/2020/
5) https://docs.google.com/forms/d/e/1FAIpQLSdpL9jizNOwOsogKpG7Jf2UlidvrqpE
oHQ1kjgW3VBiv1owUA/viewform?usp=sf_link

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