Overallotment

When a company sells shares on the stock exchange for the first time, it sets a fixed number of shares beforehand. These shares are called stock, and the first sale on the exchange is called an IPO. With an overallotment, the accompanying bank is allowed to sell more shares to buyers in advance than actually exist. This additional quantity is usually around 15 percent of the original number of shares. Whether the bank actually delivers them in the end is only decided in the weeks after the launch. The term is often equated with the word Greenshoe, which goes back to an American shoe company that first used this procedure in 1963.

Why the first day of trading is so delicate

The price of a share in an IPO is negotiated beforehand by the bank and the company. Nobody knows for certain whether the market will accept this price. If the price falls significantly on the first day, the entire IPO looks like a failure. This damages the company’s reputation and angers the early buyers.

The overallotment gives the bank a tool against exactly this risk. It can act as a buyer itself in the first few days and thereby create demand. This so-called price stabilization is explicitly permitted in Europe, but strictly regulated. It may only take place for a limited period, usually 30 days, and must be publicly announced.

For the company, the matter has a second advantage. If the IPO goes well, the additional shares bring more money and higher proceeds into the till. The overallotment is therefore not just a hedge, but also an opportunity for a larger issue.

The trick with the borrowed shares

At the start, the bank deliberately sells more shares than it owns. It usually borrows this excess quantity from the existing shareholders, i.e. the previous owners of the company. It owes them the shares and must return them at some point. This very debt is the lever for everything that follows.

If the price rises after the start of trading, the bank exercises the overallotment option. It is allowed to newly acquire the borrowed shares at the original issue price and thereby settle its debt. If, on the other hand, the price falls below the issue price, it instead buys the shares back on the exchange. This buyback supports the price because it creates additional demand. The bank even earns money on the price difference, but also bears the risk if the price fluctuates sharply.

One can think of it like a return period when shopping online. You order more than you’re certain to need, and decide later based on the actual situation. Only here the decision is bound to a clear mechanism rather than to a whim.

How to recognize an overallotment in a news report

In reports on IPOs, the term almost always appears in the fine print. Typical phrasings include statements such as “including Greenshoe” or “assuming full exercise of the overallotment option.” Anyone reading such sentences should know: the stated issue volume is then the upper limit, not the guaranteed amount.

A common misconception is the assumption that the overallotment is always fully used. In weak IPOs, it remains partially or entirely unused. Newspapers then later report that the banks only exercised the Greenshoe by half. That is a clear signal that demand was weaker than hoped.

The term must be distinguished from pure oversubscription. Oversubscribed means that investors ordered more shares than were offered. That is a demand signal. The overallotment, by contrast, is a contractual instrument that is agreed upon beforehand, independent of that.