[3][1] The term is derived from the name of the first company, Green Shoe Manufacturing (now called Stride Rite), to permit underwriters to use this practice in an IPO.
Secondly, it grants the underwriters some flexibility in setting the final size of the offer based on post-offer demand for the shares.
This can create the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares.
The underwriters can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their short position.
If the underwriters were not able to buy back any portion of the oversold shares at or below the offering price ("syndicate bid") because the stock immediately rose and stayed up, then they would completely cover their 15% short position by exercising 100% of the shoe.
"Recently, the SEC staff has learned that in the US, syndicate covering transactions have replaced (in terms of frequency of use) stabilization as a means to support post-offering market prices.
Syndicate covering transactions may be preferred by managing underwriters primarily because they are not subject to the price and other conditions that apply to stabilization.
"[6] The only pathway the underwriting syndicate has for closing a naked short position is to purchase shares in the aftermarket.
"Cast in the most negative light, price stabilization might be seen as a means of transferring risk to a relatively naïve segment of the investor population.
"[8] A reverse greenshoe is a special provision in an IPO prospectus, which allows underwriters to sell shares back to the issuer.