Definition
An allotment is the planned assignment or distribution of shares or other resources by a company to investors, underwriters, employees, or existing shareholders. In capital markets, the term most often refers to how newly issued shares are split up during a public offering.
Key players and common contexts
– Issuing company: decides how many new shares to create and why (raise cash, pay down debt, fund growth, make acquisitions, reward stakeholders).
– Underwriters: banks or broker-dealers that organize and sell the offering; they receive a portion of shares to place with investors.
– Existing shareholders: may receive shares in proportion to holdings (e.g., in a rights issue or stock split).
– Employees: receive shares through employee stock option plans (ESOs) or similar compensation programs.
How allotment works in an IPO (step-by-step)
1. Company and underwriters agree on offering size and a price approach (book-building or fixed-price).
2. Underwriters market the deal (roadshow) and collect investor orders indicating desired quantities and, in book-built deals, price interest.
3. Demand is tallied before listing. If demand exceeds supply (oversubscription), underwriters allocate shares using the prearranged method (pro rata, priority to institutions, or discretionary allocation). If demand is weak (undersubscription), pricing and allocation outcomes may be adjusted.
4. Underwriters deliver allocations to investors and list the shares on the exchange.
Key terms
– Oversubscription: total orders exceed available shares. Investors often receive only a fraction of the quantity they requested.
– Undersubscription: total orders are less than the shares on offer. The offering may be repriced downward or fail to meet expectations, which can put downward pressure on the share price after listing.
– Underwriter (or bookrunner): the financial intermediary that manages the offering and initial distribution.
– Rights issue: an offer that gives existing shareholders the right, but not the obligation, to buy additional shares, typically at a discount.
– Scrip dividend: instead of cash, shareholders are given new shares as a dividend alternative.
– Employee stock options (ESOs): contracts giving employees the option to buy company shares, commonly used for compensation and retention.
Overallotment (Greenshoe) explained
– What it is: An overallotment, commonly called a greenshoe, lets underwriters sell up to an additional 15% of the base offering size. It is an option granted by the issuer to the underwriters.
– Why it exists: The greenshoe helps underwriters stabilize the
price in the aftermarket by allowing underwriters to cover an oversold position without having to buy shares at elevated prices. Below I summarize how the mechanics work, show a numeric example, list practical checks for investors, and note regulatory and reporting points.
How the greenshoe (overallotment) works — step by step
1. Base deal: Issuer and underwriter agree on a primary offering size (base_shares) and an offer price (P_offer).
2. Option grant: Issuer grants underwriters the option to buy up to extra_shares = base_shares × overallotment_pct (commonly 15%) at the offer price. This is the greenshoe.
3. Overallotment sale: Underwriters may sell total_sold = base_shares + extra_shares into the market at the offer price during allocation (this creates a short position for the extra_shares if the issuer did not actually deliver them yet).
4. Aftermarket stabilization window: Over a stabilization period (often up to 30 days in many jurisdictions), underwriters monitor aftermarket price action and take one of two common actions to cover the short:
– If the market price rises above P_offer: exercise the greenshoe option and buy extra_shares from the issuer at P_offer to cover the short.
– If the market price falls below P_offer: buy shares in the open market at the lower price to cover the short (this buys pressure into the market and supports the price).
5. Result: The greenshoe reduces underwriter risk and can reduce volatility immediately after the IPO.
Key formulas
– extra_shares = base_shares × overallotment_pct
– total_sold = base_shares + extra_shares
– Underwriter short position = extra_shares (until covered)
– P/L if covering in market = (P_sold − P_cover) × extra_shares
– where P_sold = P_offer (what underwriter sold
and P_cover = market price when covered).
Worked numeric example (step‑by‑step)
1) Setup
– Base_shares = 10,000,000
– overallotment_pct = 15% (common maximum)
– extra_shares = 10,000,000 × 0.15 = 1,500,000
– total_sold = base_shares + extra_shares = 11,500,000
– P_offer = $20.00 (price at which underwriter sold shares to investors)
2) Two market scenarios
a) Market price rises to $22.00
– If the underwriter tried to buy in the open market to cover the short, P/L on the short = (P_sold − P_cover) × extra_shares = ($20 − $22) × 1,500,000 = −$3,000,000 (a $3M loss).
– Instead, the underwriter exercises the greenshoe: it buys the 1,500,000 extra_shares from the issuer at P_offer = $20.00 and covers the short for a net P/L of $0 on that short position.
b) Market price falls to $18.00
– The underwriter buys 1,500,000 shares in the open market at $18.00 to cover the short.
– P/L = ($20 − $18) × 1,500,000 = $3,000,000 profit on the short position.
– No greenshoe exercise is needed.
Practical checklist for underwriters (what to monitor and do)
– Before IPO: negotiate an overallotment_pct with the issuer (commonly up to 15%).
– At the offering: record the short position equal to extra_shares.
– Immediately after the IPO: monitor secondary-market trading price relative to P_offer.
– If price > P_offer: consider exercising the greenshoe to obtain shares from the issuer at P_offer and cover the short.
– If price < P_offer: buy shares in the open market to cover the short, which supports the price.
– Keep records of exercise notices, timing, and settlement for regulatory reporting.
Key benefits and limitations
– Benefits: reduces underwriter risk from post‑IPO price rises; can dampen immediate post‑IPO volatility by providing supply (when exercised) or buy pressure (when covering in market).
– Limitations: only lasts while option is exercisable (typically 30 days after the offering); size is limited by the agreed overallotment_pct; does not guarantee long‑term price stability.
Assumptions and caveats
– This example assumes the underwriter can exercise the option through contractually agreed terms and that settlement mechanics allow timely transfer of shares.
– Tax, settlement failures, short‑selling regulations, and market microstructure can affect outcomes in practice.
– The typical 15% figure is common in U.S. deals but not mandatory; other jurisdictions or transactions may use different terms.
Further reading and authoritative sources
– Investopedia — Greenshoe Option: https://www.investopedia.com/terms/g/greenshoe.asp
– U.S. Securities and Exchange Commission (SEC) — Initial Public Offerings (general info): https://www.sec.gov/fast-answers/answersipohtm.html
– Nasdaq — What Is a Greenshoe Option?: https://www.nasdaq.com/articles/what-is-a-greenshoe-option
Educational disclaimer
This explanation is for educational purposes only. It does not constitute individualized investment advice or a recommendation to buy or sell securities. Market conditions, legal terms, and tax rules vary; consult qualified professionals before acting.