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What Does "over Allotment" Mean?

Over-allotment, often termed as a "greenshoe option," is a provision in an IPO that allows underwriters to issue more shares than initially planned, typically up to 15%. This can stabilize a stock's price post-IPO by managing supply and demand. Intrigued by how this financial tool can influence market dynamics? Discover its strategic role in public offerings.
Geri Terzo
Geri Terzo

When a stock begins trading in the equity markets, the event is known as an initial public offering (IPO). An IPO is strategically planned by top executives of the company behind the new issue, investment bankers, and attorneys, and details such as timing, price, and the number of shares that will be sold are all decided ahead of time. Sometimes, there is a kink in the armor, and one of those components goes wrong. When more shares of an IPO than are available for trading are sold, it's known as an over allotment.

In can be difficult for the average individual investor to participate in an IPO. Often, a stock has one of the best trading days during its debut session, and as a result, IPO investors walk away with lucrative profits. Institutional investors are large investors, including financial institutions, that are able to purchase large numbers of shares and can dominate an IPO, leaving little room for the individual investor to share in profits in the process. If there is an over allotment of shares in an IPO, investors, whether small or big, must wait to see if other investors abandon a trade, in which case, investors who are waiting as a result of the over allotment could participate in the offering.

Man climbing a rope
Man climbing a rope

Before a new issue begins trading in the equity markets, a team of professionals, including the company's management and investment bankers at the very least, may embark on a road show. This is a traveling platform in which the merits of the forthcoming IPO are discussed. During a road show, the IPO representatives are able to gauge investor interest for the new issue before the stock even begins trading. Based on the response from the investor community, a host of details, including the number of shares that will trade, are decided.

The bankers try to get the number just right so that there are not too few shares purchased and that company executives don't look foolish. The price must accomplish a balance where there are not too many shares purchased either so that no money is left on the table. If there is, in fact, too much demand for a stock based on the number of shares issued, an over allotment is the result.

In addition to determining the number of shares that will trade, the value of those shares needs to be set. If the price per share is too high, there could be low demand on the day the IPO begins trading. An underpriced new stock could result in an over allotment of shares.

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