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A greenshoe option is a provision in an underwriting agreement that allows the underwriter to buy up to 15% of the shares in an initial public offering (IPO) at the offer price. Doing this allows the underwriters to stabilize the share prices by increasing or decreasing the supply of shares based on the public’s initial demand.

One goal for the underwriter is to sell shares to the initial purchasers as close to the targeted offering price as possible. If the underwriter determines that demand for the shares will be high, it will issue all or some of the additional shares to increase supply so the price falls back closer to the established offering price. If the underwriter anticipates that demand for the shares might be low, it will sell the issued shares plus the additional 15% of the shares, and then buy back the 15% at the offering price. This reduces the supply and props up the share price.

Sometimes a company will not allow its underwriter to have a greenshoe option.  This usually happens when the issuing company is issuing the shares for a fixed investment, such as specific capital project, and does not want to take on additional equity capital. 

The greenshoe option gets its name from the first company to offer it – The Green Shoe Manufacturing Company, now known as Stride Rite Corp. The legal name for a greenshoe option is “over-allotment option.”

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