The Relationship Between Overallotment Options, Underwriting Fees and Price Stabilization For Canadian IPOs

The overallotment option (OAO) gives underwriters the right to acquire additional shares from the issuing firm at the offer price (less underwriting fees) in order to meet any excess demand for an issue. Thus, underwriters can use overallotment options to stabilize market prices post-issue by increasing the supply of shares for oversold issues. Unlike IPOs in the U.S., the Canadian evidence finds that OAOs are included less frequently, that underwriting fees are positively associated with OAO inclusion, and that the OAO appears to play a minor role in market price stabilization, which is itself less detectable and appears to be limited to the very early stages of secondary market trading. These results suggest that the role of the OAO differs markedly for IPOs in Canadian versus U.S. markets.