What is Authorized Stock?

Authorized stock, or authorized shares, refers to the maximum number of shares that a corporation is legally permitted to issue, as specified in its articles of incorporation in the U.S., or in the company’s charter in other parts of the world. It is also usually listed in the capital accounts section of the balance sheet. Authorized shares should not be confused with outstanding shares, which are the number of shares the corporation has actually issued that are held by the public.

Authorized stock is also known as authorized shares or authorized capital stock.

Understanding Authorized Stock

When a company is formed, it decides on the maximum number of shares it would like to offer. These shares are referred to as authorized stock. The shares that are issued to the public to trade on the open markets comprise all or a portion of a company’s authorized stock. The number of shares actually available to trade is known as float. In addition, restricted shares, which are reserved for employee compensation and incentives, are also part of authorized shares. The total number of a company’s outstanding shares as seen in the balance sheet is the sum of float and restricted shares. If outstanding shares are less than authorized shares, the difference (unissued stock) is what the company retains in its treasury. A company that issues all of its authorized stock will have its outstanding shares equal to authorized shares. Outstanding shares can never exceed the authorized number, since the authorized shares total is the maximum number of shares that a company can issue.

Why a Company Might Not Issue All of Its Authorized Shares

The number of authorized shares is typically higher than those actually issued, which allows the company to offer and sell more shares in the future if it needs to raise additional funds. For example, if a company has 1 million authorized shares, it might only sell 500,000 of the shares during its initial public offering (IPO). The company might reserve 50,000 of authorized stock as stock options to attract and retain employees. It might sell 150,000 more in a secondary offering to raise more money in the future. The unissued stock that will be retained in the company’s treasury account will be 1 million – 500,000 – 50,000 – 150,000 = 300,000.

Another reason a company might not want to issue all of its authorized shares is to maintain a controlling interest in the company and prevent the possibility of a hostile takeover.

Example of Authorized Stock

Amazon’s corporate charter, for example, states that the company’s total authorized stock shall include 5 billion shares of common stock and 500 million shares of preferred stock. The charter permits Amazon to increase its authorized stock if there isn’t enough unissued common stock to allow for the conversion of preferred stock. Corporate charters often require shareholder approval to increase the number of shares of authorized stock.

An investor might want to know how many authorized shares a company has in order to analyze the potential for stock dilution. Dilution reduces a stockholder’s share of ownership and voting power in a company and reduces a stock’s earnings per share (EPS) following the issue of new stock. The larger the difference between the number of authorized shares and the number of outstanding shares, the greater the potential for dilution.

What Is an Allotment?

The term allotment refers to the systematic distribution or assignment of resources in a business to various entities over time. Allotment generally means the distribution of equity, particularly shares granted to a participating underwriting firm during an initial public offering (IPO).

There are several types of allotment that arise when new shares are issued and allocated to either new or existing shareholders. Companies allot shares and other resources when demand is much stronger than the available supply.

Understanding Allotments

In business, allotment describes the systematic distribution of resources across different entities and over time. In finance, the term typically relates to the allocation of shares during a public share issuance. When a private company wants to raise capital for any reason (to fund operations, make a large purchase, or acquire a rival), it may decide to issue shares by going public. Two or more financial institutions usually underwrite a public offering. Each underwriter receives a specific number of shares to sell.

The allotment process can get somewhat complicated during an IPO, even for individual investors. That’s because stock markets are incredibly efficient mechanisms for matching prices and quantities, but the demand must be estimated before an IPO takes place. Investors must express interest in how many shares they would like to purchase at a specific price before the IPO.

If demand is too high, the actual allotment of shares received by an investor may be lower than the amount requested. If demand is too low, which means the IPO is undersubscribed, then the investor may be able to get the desired allotment at a lower price.

On the other hand, low demand often leads to the share price falling after the IPO takes place. This means that the allotment is oversubscribed.

Other Forms of Allotment

An IPO is not the only case of share allocation. Allotment can also occur when a company’s directors earmark new shares to predetermined shareholders. These are investors who have either applied for new shares or earned them by owning existing shares. For example, the company allocates shares proportionately based on existing ownership in a stock split.

Companies allot shares to their employees through employee stock options (ESOs). This is a form of compensation that companies offer to attract new and keep existing employees in addition to salaries and wages. ESOs incentivize employees to perform better by increasing the number of shares without diluting ownership.

Rights offerings or rights issues allocate shares to investors who wish to purchase more rather than doing so automatically. Thus, it gives investors the right but not the obligation to purchase additional shares in the company. Some companies may elect to do a rights issue to the shareholders of a company they want to acquire. This allows the acquiring company to raise capital by giving investors in the target firm an ownership stake in the newly formed company.

Reasons for Raising Shares

The number one reason a company issues new shares for allotment is to raise money to finance business operations. An IPO is also used to raise capital. In fact, there are very few other reasons why a company would issue and allocate new shares.

New shares can be issued to repay a public company’s short- or long-term debt. Paying down debt helps a company with interest payments. It also changes critical financial ratios such as the debt-to-equity ratio and debt-to-asset ratio. There are times when a company may want to issue new shares, even if there is little or no debt. When companies face situations where current growth is outpacing sustainable growth, they may issue new shares to fund the continuation of organic growth.

Company directors may issue new shares to fund the acquisition or takeover of another business. In the case of a takeover, new shares can be allotted to existing shareholders of the acquired company, efficiently exchanging their shares for equity in the acquiring company.

As a form of reward to existing shareholders and stakeholders, companies issue and allot new shares. A scrip dividend, for example, is a dividend that gives equity holders some new shares proportional to the value of what they would have received had the dividend been cash.

Overallotment Options

There are options for underwriters where additional shares can be sold in an IPO or follow-on offering. This is called an overallotment or greenshoe option.

In an overallotment, underwriters have the option to issue more than 15% shares than the company originally intended to do. This option doesn’t have to be exercised the day of the overallotment. Instead, companies can take as long as 30 days to do so. Companies do this when shares trade higher than the offering price and when demand is really high.

Overallotments allow companies to stabilize the price of their shares on the stock market while ensuring it floats below the offering price. If the price increases above this threshold, underwriters can purchase the additional shares at the offering price. Doing so ensures they don’t have to deal with losses. But if the price falls below the offering price, underwriters can decrease the supply by purchasing some of the shares. This may push the price up.