Appeals Court Concludes That IPOs Are Legal

Here’s a thing that happens. When a company goes public, it sells some shares to the underwriters, and the underwriters sell more shares to the public. Let’s say the company sells 100 shares, for $10 each. The underwriters will sell 115 shares, for $10 each, and give the company $1,000 (less fees). The underwriters will keep the other $150 for themselves. They have bought 100 shares and sold 115, so they are short 15 shares. If the stock price goes down over the next few days, they use some or all of that $150 to buy the stock, so it doesn’t go down too fast.1479918653205 This is called “stabilization.” The underwriters’ buying helps keep the stock price close to the IPO price. People think that is good.

On the other hand, if the stock goes up after the IPO -- which is more common -- the underwriters don’t buy back those 15 shares in the market. (That would be expensive.) Instead, they give the company the $150 they kept (less fees), and get back 15 more shares at the IPO price of $10 each, which they use to close out their short position.1479918735993 This is called “exercising the greenshoe,” for historico-silly reasons.1479918791436 The reason that the company sells the underwriters 15 more shares at $10, even though the stock is now trading at $12 or whatever, is that the underwriting agreement for the IPO included an “overallotment option,” or “greenshoe,” obliging the company to sell the banks 15 more shares, any time in the (usually) 30 days after the offering, at the deal price, at the banks’ option.