Oversubscription (IPO) - Explained
What is Oversubscription to an IPO?
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Table of ContentsWhat is Oversubscription?How does Oversubscription Work?An instance of Oversubscription of SecuritiesAdvantages of Oversubscribed Securities and Expenses InvolvedAcademic Research for Oversubscription
What is Oversubscription?
Oversubscription is a situation where an Initial Public Offer (IPO) triggers more buyers than there are shares available. In other words, it is a condition where demand exceeds supply of shares. An oversubscription is a convenient indicator for underwriters to perform one of the following adjustments to their initial offer in order to satisfy the increasing demand:
- Increase the per-unit price of the securities on offer.
- Offer additional securities.
How does Oversubscription Work?
A security offering is said to be oversubscribed when the demand for securities on offer via an initial public offering (IPO) exceeds the actual number of available securities. This is in sharp contrast to undersubscription, where the number of shares on offer exceeds the number of shares demanded by investors, thus creating a surplus. Oversubscription is measured in terms of multiples of the available number of shares of bonds. For example, if company X issues an IPO of 20,000 shares, triggering a demand for 40,000 shares, then the X IPO can be said to be oversubscribed two times. Typically, underwriters set prices of shares or bonds on offer through an IPO in such a way as to preempt either a shortage or a surplus of offered securities. In circumstances where there arises a shortage of securities (by virtue of oversubscription), underwriters are free to increase per-unit prices of the securities on offer. This also helps the company raise additional capital for its future endeavors.
An instance of Oversubscription of Securities
Let us consider the example of one of the most eagerly-awaited initial public offerings of 2019 - the Lyft IPO. Taxi aggregator and Uber rival Lyft announced its foray into the public domain via an initial public offering that sought a $23 billion valuation. The ride hailing startup had initially targeted an indicative IPO price range of $62 to $68 per share and hoped to price the IPO by March 28, 2019. Lyfts IPO was oversubscribed a phenomenal 20 times. On March 28, 2019, the startup announced an offering of 32.5 million shares, each priced at $72, which was the upper limit of its targeted $70-$72 price range. Lyft managed to raise $2.34 billion from the IPO. The companys debut in the market on March 29, 2019 saw its share prices rise by as much as 23 percent. Lyft stock opened at $87.24, lost almost 9% of its gains, and still managed to close at $78.29. The companys market capitalization was pegged at around $22.2 billion.
Advantages of Oversubscribed Securities and Expenses Involved
An oversubscription of securities provides the company with the option to either offer additional securities for public purchase or raise its per-unit price. The company can also formulate a combination of the two approaches to meet investor demand and accumulate more capital resources. However, there exists an upper ceiling to security price increases, beyond which investors may be unwilling to pay.
Academic Research for Oversubscription
- International differences in oversubscription and underpricing of IPOs, Chowdhry, B., & Sherman, A. (1996). Journal of Corporate Finance, 2(4), 359-381. The authors analyze initial public offerings and draw up a correlation between offer price of the IPO and the number of days until bidding closes. In situations where the offer prices are set several days ahead of the day bidding closes, the authors detect the possibility of a leak of relevant price information from within the company, thus leading to two discrete scenarios: The investors may realize that the offer price is too low. This usually results in massive over subscriptions. Conversely, when the investors realize that the offer price is too high, it causes them to undersubscribe. This potentially causes failure of the issue. Companies that cannot risk undersubscription usually resort to underpricing offers. The authors note that a high possibility of information leakage usually leads to such underpricing strategies. Moreover, there exists discrepancies in oversubscription and underpricing based on the country of origin of the IPO.
- Choosing Objectives in Over-Subscription Planning., Smith, D. E. (2004, June). In ICAPS (Vol. 4, p. 393). This paper deals with the formulation of certain procedures to deal with planning issues pertaining to oversubscription.The procedure employs an abridged version of the planning problem and offers a hands-on solution to the planner, including a specification of the steps involved and the order in which they should be evaluated.
- Explaining over-subscription in fixed-price IPOsEvidence from the Malaysian stock market, Low, S. W., & Yong, O. (2011). Emerging Markets Review, 12(3), 205-216. This paper samples data from the Malaysian stock markets and draws up a correlation between oversubscription and pre listing information pertaining to offer prices of fixed price IPOs. The authors conclude that investors' opportunity cost of fund reacts negatively to oversubscription. An increase in the duration of the offer period also tends to increase investors' opportunity cost of fund, given the fact that all IPO applications mandate prepayment. This in turn lessens investors interest in the offering. Oversubscription can be achieved by timing IPOs in such ways that they synchronize with phases of lucrative initial returns, while maintaining low IPO activity volumes.
- Initial performance of Greek IPOs, underwriter's reputation and oversubscription, Kenourgios, D. F., Papathanasiou, S., & Rafail Melas, E. (2007). Managerial Finance, 33(5), 332-343. The authors sample 169 Greek stock markets and seek to substantiate IPOs based on initial performance as well as determinants of shortrun underpricing. Initially, raw and adjusted returns are used to calculate initial performance of the offerings. Subsequently, proxies are employed to rate underwriters prestige, accompanied by the times of oversubscription.
- An empirical examination of over-subscription in the Malaysian IPO market, Tajuddin, A. H., Mohd-Rashid, R., Abdullah, N. A. H., & Abdul-Rahim, R. (2015). International Journal of Economics and Management, 9 (S). The authors draw 373 IPO samples from Malaysian IPO markets and analyze the roles that informed investors play in tandem with information asymmetry in determining oversubscription ratios. Their study concludes that informed investors tend to positively influence oversubscription, but only marginally. Conversely, information asymmetry tends to negatively influence oversubscription in a much more pronounced manner.
- What Can We Learn from IPO Comparables Besides Valuation? IPO Shadow Stocks, Oversubscription Rates and Investor Sentiment in the Hong Kong Market, Cen, L. (2009). This paper samples IPO comparable stocks in the Hong Kong market. It concludes that such stocks undergo remarkable inflation in prices during the IPO filing period, especially owing to extensive media coverage. The author establishes a correlation between inflation in stock prices and high demand. He also emphasizes on the IPO subscription rate as a deciding factor that determines IPO initial returns. However, such IPO stocks are also prone to experiencing considerable price reversals in the post-listing period.
- Offline oversubscription, issue size, and market momentum: the driving forces for ChiNext IPOs' initial underpricing, Deng, Q., & Zhou, Z. G. (2015). Chinese Economy, 48(2), 114-129. The authors scrutinize ChiNext IPO samples and analyze the impetus behind the first day initial return of such offerings. As many as 29 potential explanatory variables, 4 policy break dummies, and 2 intraday trading suspension dummies are evaluated using an OLS model in order to locate statistically- significant variables. This is followed by a 2SLS mechanism that removes endogenous variables. Finally, a GARCH-M model with an ARMA(1,1) adjustment is applied to the residuals.
- Does Growth Opportunity Matter In Explaining The Oversubscription Phenomena Of Malaysian IPO?, Tajuddin, A. H., Abdullah, N. A. H., & Taufil-Mohd, K. N. (2016). Procedia-Social and Behavioral Sciences, 219, 748-754. The authors sample Malaysian IPOs and point out that in case of IPOs that have fixed price mechanisms, it is anomalous to calculate the oversubscription ratio of the IPOs prior to listing. The authors track high growth IPOs and try to determine if they are prone to oversubscription. They conclude that high growth IPOs tend to return low oversubscription ratios.
- Size of offer, over-subscription ratio and performance of malaysian IPOs, Yong, O., Yatim, P., & Sapian, R. Z. Z. (2002).Malaysian Management Journal, 6(1&2), 35-51. This paper samples IPOs listed on the Kuala Lumpur Stock Exchange and scrutinizes their initial and long-term performances. The authors deduce that there exist a significant mean initial return and mean oversubscription ratio. They also infer that there is no correlation between size of the offer and the oversubscription ratio. Moreover, returns are always decidedly higher in the initial phases than in the long run.
- A game-theoretic model of underpricing and over-subscription in Chinese IPO's, Geertsema, P., & Lu, H. (2016). Finance Research Letters, 17, 93-96. This paper samples 1121 Chinese IPOs and observes that just as in a raffle, lotteries are used to select a vast majority of the investors who would receive the available stock. The authors derive a favorable IPO deposit for a random number of investors with common risk aversion.