What it means
When a company sells new shares in an initial public offering, or a government or business issues bonds, it sets the number of securities on offer. Investors then place orders, called subscriptions.
If total orders are greater than the amount offered, the issue is oversubscribed. The organisers, called underwriters, must decide who gets what.
They may scale back each order by the same percentage, favour long-term institutions, run a lottery for small investors or raise the price. Strong demand can also lead the issuer to increase the size of the offering.
Oversubscription matters because it can influence the first-day trading price. Shares that many people wanted but could not fully obtain often rise when trading starts, as the unsatisfied buyers purchase in the market.
That is not guaranteed, because prices depend on many other factors. It is also a signal for the issuer.
A heavily oversubscribed issue may mean the price was set too low and money was left on the table. Underwriters try to set a price that raises enough capital while leaving a modest first-day gain for new investors.
Investors should beware of inflating their orders in the hope of a larger allocation. Applying for more shares than you can afford can create problems if the allocation turns out to be bigger than expected.
Retail investors usually get the smallest share of a hot offering. Institutions with large orders and good relationships with the underwriters tend to be favoured, which surprises many first-time applicants.
Applicants should therefore read the allocation policy in the prospectus (the formal offer document) before deciding how much to request.
In practice
Real-world examples.
Example
A technology company lists on a stock exchange and offers 5,000,000 shares. Orders come in for 30,000,000 shares. The underwriters scale back all orders and announce that the issue was six times oversubscribed.
Example
A government sells $2,000,000,000 of bonds and receives bids for $5,000,000,000. The treasury accepts the lowest-yield bids until the target is reached. The strong demand allows it to borrow more cheaply.
Example
A small business raises funds through a crowdfunding campaign with a target of $500,000. Backers pledge $750,000 by the closing date. The owner decides to accept the extra money to expand the product range.
Formula
Calculation
Subscription ratio = shares applied for / shares offered
Allocation percentage = shares offered / shares applied for
A company offers 2,000,000 shares at $20 each. Investors apply for 8,000,000 shares in total. Subscription ratio = 8,000,000 / 2,000,000 = 4 times, so the issue is 4 times oversubscribed. Allocation percentage = 2,000,000 / 8,000,000 = 25%. An investor who applied for 10,000 shares at $20 (a $200,000 order) receives 10,000 x 0.25 = 2,500 shares, which cost $50,000, and the remaining $150,000 is returned.
Reading the result: the issuer raises 2,000,000 x 20 = $40,000,000, while investors wanted to put in $160,000,000. That four-fold excess demand is one reason underwriters sometimes raise the price or enlarge the issue.
Where the shares rise on day one, the first-day gain shows how much value the issuer left on the table. If the shares opened at $22.40 against the $20 offer price, the gain is (22.40 - 20) / 20 = 12%, which on 2,000,000 shares equals 2,000,000 x 2.40 = $4,800,000 that went to buyers instead of the company.Case study
Seen in the real world.
Westbrook Biosciences is an illustrative, fictional company that planned to sell 3,000,000 shares at $15 to raise $45,000,000. Demand from funds was so strong that orders reached 18,000,000 shares.
The underwriters could have simply allocated one-sixth of each order, but instead the board chose to raise the price range to $17 and add 500,000 shares. The company raised 3,500,000 x 17 = $59,500,000, nearly a third more than first planned.
On the first day the shares rose 12%, which gave new investors a gain but showed that the price could have been set a little higher. This illustrative example shows why oversubscription is both good news and a prompt to review pricing.
Watch out
Common mistakes.
- Assuming an oversubscribed issue will always rise on the first day, when market conditions can change quickly.
- Placing an inflated order in the expectation of being scaled back, which can leave you with more shares than you planned to buy.
- Believing oversubscription proves the company is a good investment, when it only shows strong demand at the offer price.
Questions
People also ask.
What is the opposite of oversubscribed?
An undersubscribed issue, where investors ask for fewer securities than offered, which can force the underwriters to buy the unsold part.
What happens to the money for shares you do not receive?
It is normally returned to you or released from your account after the allocation is decided.
Can the issuer sell more than the original plan?
Often yes, through an extra allotment option sometimes called a greenshoe, which allows underwriters to sell additional shares.
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