9.2. Allocation

Allocation, also called circling, is the dividing up of an offering’s available shares among the investors who submitted indications of interest during the book-building process. Some allocation decisions are relatively straightforward—for example, the lead underwriter must ensure that there are enough round-lot shareholders to meet the listing requirements of stock exchanges. Allocation becomes more complex and sensitive in offerings that are oversubscribed. Sensing the opportunity for a quick gain, investors may clamor for shares. An underwriter must rely on experience, intuition, and a sense of independence to allocate shares appropriately.

One key area to examine is institutional demand for the offering versus retail demand. In a “hot” IPO, institutions may inflate their orders, anticipating that they will not receive the full number of shares they request; a 10% order may be whittled down to a 3% order. In fact, the institution may not actually want its 10% order, and one allocation challenge is confirming what an institutional investor actually wants. Retail investors tend to have much smaller orders that are less subject to change.

Because institutional investors are prime, highly sought-after purchasers, an offering usually includes an institutional “pot” through which institutional orders are placed. This system prevents the potential problem of an institutional investor placing an order that is too large for a single underwriter to handle and also gives the lead underwriter better visibility of institutional demand. However, it can also make it unclear which distribution participant should receive the selling concession for an