Par value is a stealthy concept found in the corporate law of the United States and in other countries that have adopted variants of American corporate law.

A simple way to define par value is "the face value of a share of stock." This is a misleading definition, though. If you buy a share of stock for $75, its par value could theoretically be just about anything: if it has a par value at all, the value is probably low, maybe $1. In most cases, the par value will be completely irrelevant to you. Unless you have a stock certificate or a copy of the articles of incorporation, you will probably never know or care what the par value of your share is. So just what does par value mean, and why is it there?

The history of par value (or, when par value meant something)

Stock exchanges have been around for hundreds of years, but they haven't always been as big as they are today. And even today, most corporations don't sell their stock publicly. Instead, they sell shares to a handful of investors, who might be individuals or other corporations, and those investors hold on to their shares for the most part, or might swap with each another, or pass shares on to their families, until the corporation "dies" and everyone cashes out (or writes off) their share of the assets.

Par value comes from an era when this was the only way to do things. Three people might have gotten together and agreed to contribute $10 apiece to form a corporation. When the articles of incorporation were drawn up, the number of shares and par value of each share would be included. For three people investing $10 each, the corporation might issue three shares with a par value of $10, six shares with a par value of $5, or thirty shares with a par value of $1. Whichever numbers its owners chose would be recorded in the articles.

In the beginning, the promoter of a corporation (i.e. the person soliciting investments) would almost always set a fixed ratio between amount invested and number of shares received in exchange for that investment. Par value turned this into an absolute legal requirement. There were several reasons to do this: for one, it ensured that shareholders received equal treatment, as they would get equity and dividend rights proportional to their investment.

The legal capital of the corporation would be determined by multiplying par value by the number of shares issued. Lenders could theoretically use this figure to know how much the corporation was worth at its outset. In practice, this was a pretty stupid idea. Here's why, and also...

Why par value doesn't matter too much any more

Back when par value was the same as the initial sale price of stock, some people learned to game the system through creative accounting. They would contribute property to a new corporation in return for stock at an inflated par value. On the balance sheet, the property would be the corporation's only capital, and because legal capital was fixed, the value of the property would magically go up. While the promoter had $10,000 in stock, the corporation might only have $5,000 worth of assets, but would still be worth $10,000 on paper.

Stocks sold at inflated par values were called watered stock, because the assets of the corporation were "watered down" to increase the apparent value of the stock. Holders of watered stock could be in trouble if a creditor foreclosed on the corporation's assets. If they had received $10,000 in stock for a $5,000 capital contribution, they would not only lose their $5,000 investment but would also be personally liable for the additional $5,000, whether they were the aforementioned promoter lying about the value of their contribution, or an innocent investor relying on par value to gauge the true value of the corporation (in which case they might have deserved this result for their stupidity).

Because par value was such an unreliable indicator of the actual value of stock, and because high par values could create liability for investors if the corporation went belly up, corporate lawyers began advising their clients to issue stocks with low par values. The legal capital or "stated capital" of the corporation would still be determined based on par value, but the balance sheet would include the investment over par value as a capital surplus, and everything would still balance. In 1915, New York got wise and authorized corporations to issue "no par stock" with no par value at all, in which case the board of directors would allocate the incoming capital between stated capital and capital surplus.

Thanks in large part to a proliferation of low par and no par stock, watered stock is less of an issue these days. The last major American court case dealing with watered stock was in 1956. (Most corporate statutes also provide that the board of directors exercises conclusive judgment of the value of any property it exchanges for stock, as long as the directors do so in good faith; watered stock still comes up in the context of fraud, though.)

What par value means today

In most places today, par value is optional. Some state laws, such as the Delaware General Corporation Law (which governs most big U.S. companies), provide that a corporation can choose between par or no par stock. Other states, following the 1984 Model Business Corporation Act, do not recognize par value but allow corporations to voluntarily place par value on their stock.

For lawyers, one of the most important considerations surrounding par value is: "How much will it cost?" States often charge a franchise fee for corporations based upon the par value of the outstanding stock, with no par stock given an arbitrary par value for purposes of the calculation. Another issue surrounding par value is that stated capital (the combined par value of all the shares outstanding) cannot be moved, removed or altered in the corporation's accounting until the corporation is liquidated or its articles of incorporation are amended by a shareholder meeting. In other words, the corporation must always have assets equivalent to the par value of all of its shares combined. This is another incentive for corporations to choose low par values.

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