See: Greenshoe. See: Underwriter.
Overallotment is the new and improved, more PC term for the option to sell more shares to the public in a given offering.
When bankers have done such an awesome job hyping...er, um, marketing a given security for sale to the public, they often receive the automatic right to sell a chunk more to the quivering, hungry masses. Like...if PJ SilverSlacks is selling 10 million shares of whatever.com to mutual and hedge funds and family offices all over the world, and they do a great job marketing, then their overallotment allowance might be something like 1.5 million extra shares, for a total sale to the public of 11.5 million shares.
Remember that they get commission on each share. Call it a nickel? A dime? Sometimes they take a spread in buying at $19.70 and reselling at $20. Depends on the flavor of the underwriter's agreement. But that's the gist.
So once the infrastructure is all paid for (meaningful fixed cost), then the contribution margin of additional shares sold is very high. That is, the sale of those additional shares didn't really cost the underwriter much, so they are happy to sell. And in most cases, companies, at the right price, are all too happy to dilute themselves a tad more but raise a boatload more cash. Everyone's happy in a bull market.
Related or Semi-related Video
Finance: What is a greenshoe option?15 Views
finance a la shmoop what is a greenshoe option. oh you should be so lucky
green shoes on leprechauns and investment bankers are such a good thing. [leprechaun smiles]
why? well because when there is so much excess money laying all over the floor
your shoes turn green from the bills as you take whatever money you can carry
and run. that's how the name happened anyway a greenshoe option is a deal term
that an investment bank negotiates for in an IPO they run. and that IPO remember
is an initial public offering of stock. this can apply also to secondary
offerings and other kinds of offerings but we're focused on an IPO here as a
green shoe lives. if that IPO is marketed so well and there is so much demand for
shares in the company from the public that the bank believes it can raise the
IPO price and sell more shares to the public then that IPO was a huge winner.
the bank will exercise its greenshoe option and instead of selling 30 million [money falls from the sky]
shares of Chucky LARM calm to the public at 12 bucks a share well it'll bring the
company public at 15 bucks a share and sell 40 million shares. the math? it
raises 600 million bucks in the latter green shoe field option versus 360
million bucks in the former. the green shoe is the extra 10 million shares that
the bank can sell and get commission on while doing so. and if you think about
that world as a 5% kind of Commission world well the banks go from 18 million
in total Commission's to 30 million. yeah nice freakin bump especially when
there's a basic fixed cost of maybe 10 million dollars in either case. so you
make a lot more profit on the 30 million story here yeah? all right and having
more shares out there trading is a good thing for the company because its shares
are then more liquid. it's easier to buy and sell larger blocks of stock and the [stocks being sold in a graphic]
big institutions like that. they tend to then take a lot more
interest in the stock and usually that leads to higher stock prices down the
line. and all that liquidity or movement shares trading back and forth well
that's more Commission dollars in the future for the bank. so check your shoes
if they're green well you're either in the money or you should really get Rover
to the vet. [green poo on a wood floor]
Up Next
What is a managing underwriter, and what is the selling group?
What is an IPO? IPO stands for initial public offering. These are used when a company decides to go public; meaning people can buy shares of the co...