Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVI. Cost of Capital and
Long−Term Financial
Policy- Raising Capital © The McGraw−Hill^561
Companies, 2002
The Aftermarket
The period after a new issue is initially sold to the public is referred to as the after-
market. During this time, the members of the underwriting syndicate generally do not
sell securities for less than the offering price.
The principal underwriter is permitted to buy shares if the market price falls below
the offering price. The purpose of this would be to support the market and stabilize the
price against temporary downward pressure. If the issue remains unsold after a time (for
example, 30 days), members can leave the group and sell their shares at whatever price
the market will allow.^6
The Green Shoe Provision
Many underwriting contracts contain a Green Shoe provision(sometimes called the
overallotment option), which gives the members of the underwriting group the option to
purchase additional shares from the issuer at the offering price.^7 Essentially all IPOs and
SEOs include this provision, but ordinary debt offerings generally do not. The stated
reason for the Green Shoe option is to cover excess demand and oversubscriptions.
Green Shoe options usually last for about 30 days and involve no more than 15 percent
of the newly issued shares.
The Green Shoe option is a benefit to the underwriting syndicate and a cost to the is-
suer. If the market price of the new issue goes above the offering price within 30 days,
the Green Shoe option allows the underwriters to buy shares from the issuer and imme-
diately resell the shares to the public.
Lockup Agreements
Although they are not required by law, almost all underwriting contracts contain so-
called lockup agreements. Such agreements specify how long insiders must wait after
an IPO before they can sell some or all of their stock. Lockup periods have become
fairly standardized in recent years at 180 days. Thus, following an IPO, insiders can’t
cash out until six months have gone by, which ensures that they maintain a significant
economic interest in the company going public.
Lockup periods are also important because it is not unusual for the number of locked-
up shares to exceed the number of shares held by the public, sometimes by a substantial
multiple. On the day the lockup period expires, there is the possibility that a large num-
ber of shares will hit the market on the same day and thereby depress values. The evi-
dence suggests that, on average, venture capital–backed companies are particularly
likely to experience a loss in value on the lockup expiration day.
CONCEPT QUESTIONS
16.4a What do underwriters do?
16.4bWhat is the Green Shoe provision?CHAPTER 16 Raising Capital 533Green Shoe provision
A contract provision
giving the underwriter
the option to purchase
additional shares from
the issuer at the offering
price. Also called the
overallotment option.lockup agreement
The part of the
underwriting contract
that specifies how long
insiders must wait after
an IPO before they can
sell stock.(^6) Occasionally, the price of a security falls dramatically when the underwriter ceases to stabilize the price. In
such cases, Wall Street humorists (the ones who didn’t buy any of the stock) have referred to the period
following the aftermarket as the aftermath.
(^7) The term Green Shoe provision sounds quite exotic, but the origin is relatively mundane. The term comes
from the name of the Green Shoe Company, which, in 1963, was the first issuer that granted such an option.