[Commerce Class Notes] on Oversubscription of Shares Pdf for Exam

When the demand for a new issue of the stock exceeds the number of shares available, the term “oversubscribed” is used. When a new issue is oversubscribed, underwriters or other financial institutions selling the asset might raise the price or provide more securities to account for the higher-than-expected demand.

In contrast to an oversubscribed offer, where demand exceeds the available supply of shares, an undersubscribed issue occurs when demand exceeds the available supply of shares.

When a company decides to go public or issue new shares, it does so via IPO (Initial Public Hearing). That company asks for applications from buyers, and based on that; it allots shares.

However, in realistic scenarios, it is improbable that a firm receives the same number of applications equal to the shares issued. It is either oversubscribed or undersubscribed.

What is Oversubscription of Share?

Oversubscription of shares is a situation that occurs when a company receives more applications to purchase their shares compared to the number of shares that they have issued. It is a situation in which buyers show so much interest in a new stock that demand exceeds supply. 

Before issuing new shares, underwriters study the market to understand the number of potential investors, people who may or may not purchase these new shares. Based on such calculations, firms issue a fixed number of shares.

When investors order more than what has been issued, it creates an oversubscription. This situation of oversubscription of shares may affect the prices of an individual share. 

Thus, the issuing house or firm is responsible for dealing with this situation. They take the necessary measures to manage this scenario.

How to Deal With Oversubscription?

According to the guidelines of SEBI (Securities and Exchange Board of India), companies cannot reject applications outright. However, they can do so if there are any mistakes with the applications like –

• Incomplete information

• Absence of required documents

• Discrepancies with signature

• Submission of incorrect application amount.

• Last but not least, improperly filled application form

What are the Ways?

In a scenario of oversubscription, a company can’t fulfill the market demand. Therefore, opt for the following measure to counter this situation.

1. Pro-Rata Allotment

Pro-rata allotment means no applicant is rejected. However, they will not receive the desired amount of shares. Everyone receives shares according to the ratio of the total number of applicants/ total number of shares issued. 

For instance, ABC Ltd. is planning to offer 40,000 shares to the public via IPO. However, it receives 80,000 share applications. Therefore, the company opt for this method, where it has allotted the total shares to every applicant.

Thus, the ratio here will be 80,000:40,000, i.e. 2:1. Hence, every applicant for their application of two shares will now receive one share. Pro-rata allotment makes sure that every applicant receives at least some shares against their application.

2. Rejecting Applications

The easiest way to deal with over-subscription shares is to reject some applications. According to the SEBI guidelines, companies can do so if they find any incomplete applications. In such cases, the application money is refunded. For example, if a company receives 10,000 applications against their 6,000 share, it can reject the remaining 4,000 in case there are any discrepancies.

3. A Combination of Both

However, among the excess applications, not everyone makes a mistake and cannot be rejected on that ground. In such a scenario, a company opts for a middle ground. Here, firms accept the first set of applications in full. Amongst the remaining ones, shares are allotted on a pro-rata basis. 

For example, XYZ Ltd. is planning to release 20,000 shares in the market. However, they receive 30,000 applications against it. Therefore, in this scenario, this company can accept the first 20,000 applications in full and among the remaining 10,000 distribute shares to 6,000 as per a pro-rata basis. 

A Real-Life Example of Oversubscription of Shares

In 2012, market analysts indicated that Facebook is finally issuing its long-awaited IPO. The company was looking to raise around USB10.6 billion via 337 million shares. Prices of stocks were in the range of USB28 to USB35. Once this news broke, it created an enormous buzz in the market and resulted in an oversubscribed IPO. 

As a result, the company took advantage of this situation. It increases the number of shares from 337 million to 421 million. Additionally, it increases the share price to USB34 to USB38 per share. Thus, Facebook and its underwriters made the most of this situation generated more capital and increased its market valuation. 

Benefits of Oversubscription

Companies aim to make the most of it in a situation of oversubscription. They can manage this scenario via different techniques like increasing the number of allotted shares, rejecting applications, trying combinations of both, etc. They aim to meet market demand and raise as much capital as they can. 

How can a Company Issue More Shares?

Every company holds back a substantial amount of shares for a future capital generation or to distribute as management incentives. Therefore, firms can add further shares in case an IPO is oversubscribed. 

Share Price Management in an Oversubscribed IPO

In case the underwriters of the company can predict that there is enough buzz in the market about their IPO, they intentionally set the share prices low to sell all the shares. They do not want to be left with the remaining shares. Therefore, if there is any situation of oversubscription in the future, it leaves them with the scope of hiking up the share price.

However, universal trends show that oversubscribed shares are mostly under-priced to some extent. It allows a post-IPO hike in prices and robust trading of respective shares. 

Are there any Disadvantages of Oversubscription?

Well, a complaint against this situation is that investors often get snubbed. When firms cannot issue any more shares, they reject applications. On the other hand, investors often receive a lower amount of shares compared to what they have applied for.

 

Oversubscription of shares is a vital topic to cover for every commerce student. Apart from this, if they want to learn more about other topics of commerce, they can visit the official website of .

Key Takeaways of Oversubscription of Shares

• An oversubscribed stock offering is one in which the demand for the stock outnumbers the supply.

• An oversubscribed initial public offering (IPO) indicates that an investor may want to buy a company’s stock, resulting in a higher price and/or more stock being available for sale.

• The demand must eventually reconcile with the security’s underlying corporate fundamentals, therefore an overcrowded offering does not automatically indicate the market will support the higher price for long.