Bolton confirmed on Wednesday that they would not be offering a contract extension to their 36-year-old captain, who has played 407 times for the club over the last 10 seasons. The fact that his contract expires five days before the 10th anniversary of his arrival meant Davies believed he would not be awarded a testimonial.
Bolton defended their conduct, saying they are happy to give Davies a testimonial. But West Ham boss Allardyce said: "Every footballer has to face the fact that his career comes to an end at some stage at whatever football club you've been at, but the timing and the way that Bolton have handled it isn't very good."
He went on: "I think they've handled it poorly.
"It has been a great shame when it happens to somebody who has been such a great servant. Someone who I brought there when he was released by Southampton."
Davies was shocked and hurt at Bolton's decision to release him as he felt he would carry on playing at the Reebok Stadium until moving on to the club's coaching staff.
The Sheffield-born striker played a big role in Bolton's 11-year stay in the Barclays Premier League and went on to earn his only England cap against Montenegro in 2010.
Allardyce, who heavily relied upon Davies during his eight years at Bolton, thinks the striker deserves to be remembered as one of the all-time greats at the Lancashire club.
"I thought at the time he would be a great acquisition, but I never expected him to be such a major force in what I and we did at the time and continue to do when I left," said Allardyce, who departed Bolton for Newcastle in 2007.
"Over 10 years for all but five days and then to be released on his birthday was pretty insensitive and I think they could have handled it an awful lot better as a football club and should have done."