29 - company to put a value for the stock on the company's...

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What role does par value play in the pricing and sale of common stock by the issuing corporation? Why do most firms assign relatively low par values to their shares? Par value, sometimes referred to as face value, is the nominal value assigned to an underlying security. Par value has little significance in determining the market value of common stock. The par value of a share of stock is the value stated in the corporate charter below which shares of that class cannot be sold upon initial offering; the issuing company promised not to issue further shares below par value, so investors could be confident that no one else was receiving a more favorable issue price. Thus, par value is a nominal value of a security, which is determined by an issuing company as a minimum price. This was far more important in unregulated equity markets than in the regulated markets that exist today. Par value also has bookkeeping purposes. It allows the
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Unformatted text preview: company to put a value for the stock on the company's financial statement. Many common stocks issued today do not have par values; those that do (usually only in jurisdictions where par values are required by law) have extremely low par values (often the smallest unit of currency in circulation). Because par value is 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 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. Many states prohibit firms from selling shares at a price below par value; there is a clear incentive to set this value low....
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This note was uploaded on 10/15/2011 for the course FIN 550 taught by Professor Smith during the Spring '11 term at Berklee.

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