Stockholders' Equity: Classes of Capital Stock

The corporation

Par value and no-par capital stock

Many times, companies issue par value stock. Par value is an arbitrary amount assigned to each share of a given class of stock and printed on the stock certificate. Par value per share is no indication of the amount for which the stock sells; it is simply the amount per share credited to the capital stock account for each share issued. Also, the total par value of all issued stock often constitutes the legal capital of the corporation. The concept of legal capital protects creditors from losses. Legal capital, or stated capital, is an amount prescribed by law (usually the par value or stated value of shares issued) below which a corporation may not reduce stockholders' equity through declaration of dividends or other payments to stockholders. Stated value relates to no-par stock and is explained below. Legal capital does not guarantee that a company can pay its debts, but it does keep a company from compensating owners to the detriment of creditors. The formula for determining legal capital is:

\text { Legal Capital }=\text { Shares Issued X Par(Stated) Value }

In 1912, the state of New York first enacted laws permitting the issuance of nopar stock (stock without par value). Many other states have passed similar, but not uniform, legislation.

A corporation might issue no-par stock for two reasons. One reason is to avoid confusion. The use of a par value may confuse some investors because the par value usually does not conform to the market value. Issuing a stock with no par value avoids this source of confusion.

A second reason is related to state laws regarding the original issue price per share. A discount on capital stock is the amount by which the shares' par value 185 exceeds their issue price. Thus, if stock with a par value of USD 100 is issued at USD 80, the discount is USD 20. Most states do not permit the original issuance of stock at a discount. Only Maryland, Georgia, and California allow its issuance. The original purchasers of the shares are contingently liable for the discount unless they have transferred (by contract) the discount liability to subsequent holders. If the contingent liability has been transferred, the present stockholders are contingently liable to creditors for the difference between par value and issue price. Although this contingent liability seldom becomes an actual liability, the issuance of no-par stock avoids such a possibility.

The board of directors of a corporation issuing no-par stock may assign a stated value to each share of capital stock. Stated value is an arbitrary amount assigned by the board to each share of a given class of no-par stock. The board may set this stated value, like par value, at any amount, although some state statutes specify a minimum amount, such as USD 5 per share. If not specified by applicable state law, the board may establish stated value either before or after the shares are issued.