Why do Stocks have Par Value or Stated Value, and Why is this Less than the Market Price?
When a company first becomes incorporated, the state of incorporation must approve the number of shares of stock that the corporation is authorized to sell—authorized stock, or capital stock. Many states require that the stocks also have a par value, or nominal value, to provide a minimum amount of legal capital to pay creditors. The legal capital is equal to the par value multiplied by the number of shares of outstanding stock, which is the number of shares currently held by investors. The corporation is not legally permitted to pay dividends or buy back its own stock, if doing so reduces the amount of legal capital below the required minimum. The par value is printed on each stock certificate. The par value of each stock is also changed accordingly by stock splits. A 2-for-1 split, for instance, would halve the par value.
The par value is often $1 or less, which is much less than the market price or the expected market price of the stock. The par value is set low, because the stock cannot be issued for less than par value. If par value were higher and if the demand for the stock was less than anticipated, the corporation would be unable to sell the number of shares that it planned, since it would not be able to lower its price below par value in order to increase demand for its stock. Moreover, the cost of incorporation in some states is based on the total par value of the stocks being registered, so minimizing the par value reduces the cost of incorporation in those states.
The issue price is the amount for which the stock is sold. The difference between the issue price and the par value is recorded in the company's books as the share premium:
Share Premium = Issue Price – Par Value
The par value of preferred stock is much higher than common stock because preferred stock pays a fixed dividend that is a designated percentage of par value.
No-par stocks have no par value printed on its certificates. Instead of par value, some states allow no-par stocks to have a stated value, set by the board of directors of the corporation, which serves the same purpose as par value in setting the minimum legal capital that the corporation must have after paying any dividends or buying back its stock.
If a corporation's stock has neither par value nor stated value, then the legal capital required is equal to the total amount received when the stock was first issued.
Related Links
Common Stocks, Preferred Stocks—Basic Concepts
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