Capital Stock of No Par Value*

BY FREDERICK H. HURDMAN

For many years it has been recognized by the business world that there were evils inherent in the custom of issuing capital stock with an arbitrary dollar value on each certificate. For this reason such prominent attorneys as Francis Lynde Stetson, Louis Marshall, Victor Morawetz and the late Edward M. Shepard, of the New York bar, advocated the proposition of authorizing corporations to issue stock without par value.

Mr. Shepard, in an address which he made before the Illinois Bar Association in 1907, among many other arguments advanced by him in favor of this form of capital stock, said that it would have a tendency to direct attention to real instead of fictitious values; that it would check inflation of assets in order that sufficient debits might appear on the statements of corporations to offset the nominal value arbitrarily placed upon the certificates of stock issued; and that the unsuspecting investor would not be misled into thinking that because the symbol $100 appeared on a certificate of stock it must have a real value at or near that amount. Furthermore, he could not find any real advantage in assigning a nominal or fictitious value to the certificate.

His definition of "overcapitalization" was not that a company had too much capital, but the very contrary. The distinction is well made between "capital" and "capitalization." It is the excess of nominal capital over real capital which is the offense.

The modern corporation is nothing more nor less than a restricted form of partnership. Such differences as exist lie in the fact that the corporation may have a life not dependent upon its membership; the members may transfer their rights and liabilities; and there is a limit of liability for debts.

According to Mr. Shepard the origin of the legal requirement that the articles or certificate of incorporation shall state a company's capitalization seems to have been in the original identity between nominal capitalization and actual capital or net assets.

When the English crown issued or the English parliament authorized corporate charters, there was a jealousy of the money A paper read at the annual meeting of the American Institute of Accountants, Cincinnati, Ohio, September 16, 1919.

power of the corporation. A charter frequently, as in the time of Queen Elizabeth, gave or sought to give a monopoly of some kind to a corporation. The power of the corporation was dreaded. It was at least a matter of privilege or favor. It was, therefore, to be limited to such and such an amount of wealth. In our time, and certainly for our country, this purpose has been practically lost. We have the Standard Oil Company of New Jersey capitalized at $100,000,000 with actual capital five times that amount.

In January, 1892, a report was made to the New York State Bar Association by a committee consisting of Francis Lynde Stetson, D. S. Remsen and Robert T. Turner, suggesting a law for a distinct class of business corporations whereby they might issue their capital stock without money denomination, merely representing proportional shares in that enterprise.

The general mining laws of Prussia enacted in 1865 provided for companies without denomination of shares.

Louis Marshall gave as his opinion recently:

Eventually it will not only become a part of the jurisprudence of most of the states of the union, but in twenty years from now few corporations will be organized on any other principle.

I believe it to be the only reasonable method of representing stock ownership in a corporation. The old method of placing an arbitrary dollar mark on a certificate of incorporation led to stock-watering, the creation of false values, and proved to be an easy medium for carrying out fraudulent schemes and practices. Under the new system every share of stock represents an aliquot interest in the corporate assets. Its value is dependent upon the actual value of the assets, and not upon any fictitious or imaginary value. That is the honest way of issuing stock. In the past a corporation which acquired undeveloped mining property issued shares of stock by the thousands and arbitrarily fixed the value of the shares at amounts which varied from $1 to $100 each. Those corporations had capital stock to the amount of $1,000,000 or $100,000,000, which had merely a potential value; but speculation was carried on with the idea that the par value had some relation to actual value. It is unnecessary for me to say that such practices are inimical to the public interest. It has now become the usual thing for corporations which are honestly managed to issue their stock without par value. The experiment has proven most satisfactory, and bankers who at first were skeptical are now found to favor the issuance of stock on this new and reasonable theory.

Furthermore, the commendation of the railroad securities commission, whose report was transmitted to congress in 1911, brought the proposition prominently before the entire country. The New York State Bar Association early prepared an amendment to the New York corporation law which was finally enacted in 1912. In that report the commissioners said:

We do not believe that the retention of the hundred dollar mark, or any other dollar mark, upon the face of the share of stock is of essential importance. We are ready to recommend that the law should encourage the creation of companies whose shares have no par value and permit existing companies to change their stock into shares without par value whenever their convenience requires it. After such conversion any new shares could be sold at such price as was deemed desirable by the board of directors, with the requirement of publicity as to the proceeds of the sale of such shares and as to the disposition thereof; giving to the old shareholders, except in some cases of reorganization or consolidation, prior rights to subscribe pro rata, if they so desired, in proportion to the amount of their holdings.

As between the two alternatives of permitting the issue of stock below par or authorizing the creation of shares without par value, the latter seems to this commission the preferable one. It is true that it will be less easy to introduce than the other because it is less in accord with existing business habits and usages; but it has the cardinal merit of accuracy. It makes no claims that the share thus issued is anything more than a participation certificate.

The objections to the creation of shares without par value are two in number: first, that their issue will permit inflation, by making it easy to create an excessive number of shares; and, second, that it will produce a division of roads into two classes, those whose shares have a par value and those whose shares have not. The second of these objections does not appear to be a very serious one. There are listed on the stock exchanges today, side by side with one another, shares of the par value of one hundred dollars, shares of the par value of fifty dollars, shares with very much smaller par value, and a few, like the Great Northern Ore certificates, with no par value at all. The share sells in each case simply for what the public supposes it to be worth as a share. The danger of inflation deserves more serious consideration. We believe, however, that it is more apparent than real, because shareholders will be jealous of permitting other shareholders to acquire shares in the association except at full market value, and will not permit the issue of such shares to themselves at prices so low as seriously to impair the market or other value of their holdings. Shares either with or without par value, and whether sold at par or above par or below it, should, except in cases of consolidation and reorganization, be offered in the first instance to existing shareholders pro rata.

The issue of stock without par value offers special facilities for consolidation and reorganization.

Where two roads have consolidated, whose shares have different market values, it has been the custom to equalize the difference by the issue of extra shares of the consolidated company to the owners of the higher priced stock. This practice has always tended to produce increase of capital issues, and may readily cause the new stock to be issued for a consideration less than its par value. The only alternative was to scale down some of the old stocks; and this often involved serious difficulties, both of business policy and of law. By the simple expedient of omitting the dollar mark from the new shares, the number can be adjusted to the demands of financial convenience, without danger of misrepresentation or suspicion of unfairness to anyone.

In the case of reorganization, the advantage of shares without par value is even more obvious. It is here that the necessity and justice of getting money from stockholders is greatest. It is here that the impossibility of getting them to pay par for new shares is most conspicuous. We believe that in such cases the public interest would be subserved and the speedy rehabilitation of the roads promoted by requiring the conversion of the common stock and encouraging the conversion of the pre

ferred stock into shares without par value; the certificates simply indicating the proportionate or preferential claims of the holders upon assets and upon such profits as might from time to time be earned.

All of these considerations seem to apply with equal force to the securities of railroads under state incorporations, and we believe the laws of the several states could with advantage be modified so as to provide for the issuance of stock without par value.

Since the original bill, which was passed by the legislature of the state of New York in 1912, nine other states have enacted laws providing for the issuance of stock of nominal or no par value, so that today we find these statutes in California, Delaware, Illinois, Ohio, Pennsylvania, Maine, Maryland, New Hampshire, New York and Virginia.

A study of the laws of these various states discloses the desirability of a movement for uniformity in corporate legislation. In the table (on pages 254 and 255) there is presented a brief synopsis of the important elements entering into these laws. This is not meant to be authoritative, as in many instances the entire act should be considered in order to understand fully the limitations set down.

The New York state law contemplates a corporation whose creditors are advised at the formation of the company that the actual paid-in capital of the company is at least a given amount. The capital stock without par value may be issued at any value within the methods provided, subject only to the requirement that the actual paid-in capital shall equal in amount the stated capital before the corporation shall begin to carry on business or shall incur any debts.

The corporation may sell its authorized shares from time to time for such consideration as may be prescribed in the certificate of incorporation or for such consideration as shall be the fair market value of such shares-and in the absence of fraud in the transaction, the judgment of the board of directors as to such value shall be conclusive-or for such consideration as shall be consented to by the holders of two-thirds of each class of shares then outstanding.

A peculiar feature of the Virginia law is that it provides that "the maximum amount of the authorized capital stock of the corporation shall be stated in dollars in the application for a charter." As the number of shares must also be stated it would appear that a nominal value is thus established.

It is interesting to note that in the New York law, and that of other states modeled after it, not only is there an attempt to provide that creditors shall have due notice of the minimum capital invested before the privilege of doing business is granted to the corporation, but the law has further restricted the reduction of the actual capital of the business to an amount less than the stated capital stock unless it be determined by the proper authorities that the reduced amount of capital is sufficient for the purpose of the business and is in excess of the ascertained debts and liabilities. The statute of Ohio, however, provides that preferred stock may not be redeemed, purchased or retired if thereby the property and assets of the corporation will be reduced below the amount of the outstanding liabilities, but in providing for the reduction of common stock the law states that the reduced amount of capital must be in excess of its debts and liabilities.

Whether the framers of the law really meant, in both cases, that the assets should still exceed the liabilities or whether it was the intention in reducing capital to leave $2 of assets for every $1 of liabilities is not clear; but at any rate in the New York law and that of several other states it is specifically stated that the capital remaining shall be in excess of the debts and liabilities. It will be noted that the word "capital" in the statute is used exclusively in the sense of stockholders' equity.

It is further provided by the laws of most of the states that no dividend shall be declared which will reduce the amount of the capital below the stated capital, and the directors are made liable to the corporation or to its creditors for any dividend paid in violation of this principle. The Ohio law, in addition to forbidding the dividend which will reduce the capital below the amount of stated capital, also provides that dividends shall not be paid from any fund received from the sale or disposition of its capital stock.

The New York law in referring to methods of taxation provides that the rate of dividend shall be computed by dividing the total amount of dividends which had been paid during the year by the amount of the net assets of the corporation on the first day of the year. This departure from the custom of considering the dividend as being based on originally paid-in capital