'Incorporation'

The process of legally declaring a corporate entity as separate from its owners. Incorporation has many advantages for a business and its owners, including:

1) Protects the owner's assets against the company's liabilities2) Allows for easy transfer of ownership to another party3) Achieves a lower tax rate than on personal income4) Receives more lenient tax restrictions on loss carry forwards5) Can raise capital through the sale of stock

Incorporation involves drafting an "Articles of Incorporation", which lists the primary purpose of the business and its location, along with the number of shares and class of stock being issued, if any. Incorporation will also involve state-specific registration information and fees.

'Retained Earnings'

Retained earnings is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt. It is recorded under shareholders' equity on the balance sheet.

The formula calculates retained earnings by adding net income to (or subtracting any net losses from) beginning retained earnings and subtracting any dividends paid to shareholders:

Retained Earnings (RE) = Beginning RE + Net Income - Dividends

Also known as the "retention ratio" or "retained surplus".

Corporate governanceCorporate governance broadly refers to the mechanisms, processes and relations by which corporations are controlled and directed.[1] Governance structures and principles identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and includes the rules and procedures for making decisions in corporate affairs.[2] Corporate governance includes the processes through which corporations' objectives are set and pursued in the context of the social, regulatory and market environment. Governance mechanisms include monitoring the actions, policies, practices, and decisions of corporations, their agents, and affected stakeholders. Corporate governance practices are affected by attempts to align the interests of stakeholders.[3][4] Interest in the corporate governance practices of modern corporations, particularly in relation to accountability, increased following the high-profile collapses of a number of large corporations during 2001–2002, most of which involved accounting fraud; and then again after the recent financial crisis in 2008.

Principles of Corporate Governance

Rights and equitable treatment of shareholders:[18][19][20] Organizations should respect the rights of

shareholders and help shareholders to exercise those rights. They can help shareholders exercise

their rights by openly and effectively communicating information and by encouraging shareholders to

participate in general meetings.

Interests of other stakeholders:[21] Organizations should recognize that they have legal, contractual,

social, and market driven obligations to non-shareholder stakeholders, including employees,

investors, creditors, suppliers, local communities, customers, and policy makers.

Role and responsibilities of the board:[22][23] The board needs sufficient relevant skills and

understanding to review and challenge management performance. It also needs adequate size and

appropriate levels of independence and commitment.

Integrity and ethical behavior:[24][25] Integrity should be a fundamental requirement in choosing

corporate officers and board members. Organizations should develop a code of conduct for their

directors and executives that promotes ethical and responsible decision making.

Disclosure and transparency:[26][27] Organizations should clarify and make publicly known the roles

and responsibilities of board and management to provide stakeholders with a level of accountability.

They should also implement procedures to independently verify and safeguard the integrity of the

company's financial reporting. Disclosure of material matters concerning the organization should be

timely and balanced to ensure that all investors have access to clear, factual information.

Types of CapitalizationThe study of capitalisation involves an analysis of three aspects:

i) amount of capital

ii) composition or form of capital

iii) changes in capitalisation.

Capitalisation may be of 3 types. They are over capitalisation, under capitalisation and fair capitalisation. Among these three over capitalisation is likely to be of frequent occurrence and practical interest.

Over Capitalisation:

Many have confused the term ‘over-capitalisation’ with abundance of capital and ‘under-capitalisation’

with shortage of capital. It becomes necessary to discuss these terms in detail. An enterprise becomes

over-capitalised when its earning capacity does not justify the amount of capitalisation.

Over-capitalisation has nothing to do with redundance of capital in an enterprise. On the other hand, there

is a greater possibility that the over-capitalised concern will be short of capital. The abstract reasoning

can be explained by applying certain objective tests. These tests require the comparison between the

different values of the equity shares in a corporation. When we speak in terms of over-capitalisation we

always have the interest of equity holders in mind.

There are various standards of valuing corporation or its equity shares:

Par value:

It is not the face value of a share at which it is normally issued, i.e., at premium nor at discount, it is static

and not affected by business oscillations. Thus it fails to reflect the various business changes.

Market Value:

It is determined by factors of demand and supply in a stock market. It is dependent on a number of

considerations, affecting demand as well as supply side.

Book Value:

It is calculated by dividing the aggregate of the proprietary items – like share capital, surplus and

proprietary reserves – by the number of outstanding shares.

Real Value:

It is found out by dividing the capitalised value of earnings by the number of outstanding shares. Before

the earnings are capitalised, they should be calculated on an average basis. It may be pointed out at this

place that longer the period cover by the study, the more representative the average will be the period

should normally cover all the phase of business cycle, i.e., good, bad, and indifferent years. Some

authors compare the par value of the share with the market value and if par value is greater than the

market value they regard it as a sign of over-capitalisation.

Par value > Market value

The comparison of book and real values of shares is a better test in the sense that the book value gives

an idea about the company’s past career i.e., how it had fared during the last few years, and its strength

is determined by its reserves and surplus.

Real value is a study of the working of company in the light of the earning capacity in the particular line of

business. It takes into account not only the previous earnings or earning capacity of a concern but relates

the earnings to the general earning capacity of other units of the same nature. It is a scientific and logical

test.

Book Value = Real Value (Fair capitalisation)

Book Value > Real Value (Over-capitalisation)

Book Value < Real Value (Under capitalisation)

Causes of over-capitalization:

The following are the cases for over-capitalisation:

i) Promotion with inflated asset:

The promotion of a company may entail the conversion of a partnership firm or a private company into a

public limited company and the transfer of assets may be at inflated prices which do not bear any relation

to the earning capacity of the concern. Under these circumstances, the book value of the corporation will

be more than its real value.

ii) The incurring of high establishment or promotion expenses (ex: good will, patent rights) is a potent

cause of over-capitalisation. If the earnings later on do not justify the amount of capital employed, the

company will be over-capitalised.

iii) Inflationary conditions:

Boom is a significant factor for making the business enterprises over-capitalised. The newly started

concern during the boom period is likely to be capitalised at a high figure because of the rise in general

price level and payment of high prices for the property assembled. These newly floated concerns as well

as the reorganised and expanded ones find themselves over-capitalised after the boom conditions

subside.

iv) Shortage of capital:

The shortage of capital is also a contributory factor of over-capitalisation, the inadequacy of capital may

be due to faulty drafting of the financial plan. Thus a major part of the earnings will not be available for the

shareholders which will bring down the real value of the shares.

v) Defective depreciation policy:

It is not uncommon to find that many concerns are over-capitalised due to insufficient provision for

depreciation/replacement or obsolescence of assets. The efficiency of the company is adversely affected

and it is reflected in its reduced profit yielding capacity.

vi) Liberal Dividend Policy:

If corporations follow liberal dividend policy by neglecting essential provisions, they discover themselves

to be overcapitalized after a few years when book value of their shares will be higher than the real value?

vii) Taxation Policy:

Over-capitalisation of an enterprise may also be caused due to excessive taxation by the Government

and also their basis of calculation may leave the corporations with meagre funds.

Effects of over capitalisation:

Over-capitalisation affects the company, the shareholders and the society as a whole. The confidence of

Investors in an over-capitalised company is injured on account of its reduced earning capacity and the

market price of the shares which falls consequently. The credit-standing of a corporation is relatively poor.

Consequently, the credit-standing of a corporation is relatively poor. Consequently, the company may be

forced to incur unwieldy debts and bear the heavy loss of its goodwill In a subsequent reorganization. The

Shareholders bear the brunt of over capitalization doubly. Not only is their capital depreciated but the

income is also uncertain and mostly irregular. Their holdings have little value as collateral security.

An over-capitalised company tries to increase the prices and reduce the quality of products, and as a

result such a company may liquidate. In that case the creditors and the Labourers will be affected. Thus it

leads to the misapplication and wastage of the resources of society.

Corrections for over-capitalisation:

Overcapitalization can be rectified if the following steps are taken:

1. Reorganisation of the company by selling shares at a high rate of discount.

2. Issuing less interested new debentures on premium in place of old debentures.

3. Redeeming preference shares carrying high dividend

4. Reducing the face value (par value) of shares.

Under-Capitalisation:

Generally, under-capitalisation is regarded equivalent to the inadequacy of capital but it should be

considered as the reverse of over-capitalisation i.e. it is a condition when the real value of the corporation

is more than the book value.

The following are the causes for under-capitalization:

1. Underestimation of earnings:

Sometimes while drafting the financial plan, the earnings are anticipated at a lower figure and the

capitalisation may be based on that estimate; if the earnings prove to be higher the concern shall become

under-capitalised.

2. Unforeseeable increase in earnings:

Many corporations started during depression find themselves to be under-capitalised in the period of

recovery or boom due to unforeseeable increase in earnings.

3. Conservative dividend policy:

By following conservative dividend policy some corporations create adequate reserves for depreciation,

renewals and replacements and plough back the earnings which increase the real value of the shares of

those corporations.

4. High efficiency maintained:

By adopting ‘latest techniques of production many companies improve their efficiency. The profits being

dependent on the efficiency of the concern will increase and, accordingly, the real value of the corporation

may exceed its ‘book value’.

Effects of under-capitalisation:

The following are the effects of under-capitalisation:

1. Causes wide fluctuations in the market value of shares.

2. Provoke the management to create secret reserves.

3. Employees demand high share in the increased prosperity of the company.

Different Types of Stocks and Stock Classifications

Common StockCommon stock is as it sounds, common. When people talk about stocks they are usually referring to

common stock, and the great majority of stock is issued is in this form. Common stock represent

ownership in a company and a claim on a portion of that companies profits (dividends). Investors can also

vote to elect the board members who oversee the major decisions made by management.

Historically, common stock has yielded higher returns than almost all other common investment classes.

In addition to the highest returns, common stock probably also carries the highest risk. If a company goes

bankrupt, the common shareholders will not receive money until the creditors, bondholders and preferred

shareholders are paid.

This risk can be greatly reduced by owning many different well established companies (diversification)

that have solid financial statements and a history of strong earnings.

Preferred StockPreferred stock represents some degree of ownership in a company but usually doesn’t come with the

same voting rights. With preferred shares, investors are usually guaranteed a fixed dividend. Recall that

this is different than common stock, which has variable dividend payments that fluctuate with company

profits. Unlike common stock, preferred stock doesn’t usually enjoy the same appreciation (or

depreciation in market downturns) in stock price, which results in lower overall returns. One advantage of

preferred stock  is that in the event of bankruptcy, preferred shareholders are paid off before the common

shareholder (but still after debt holders).

I like to think of preferred stock as being somewhere in between bonds and common stock. It shares

similarities with both. As a result, I wouldn’t hold preferred stock. I don’t really see any reason to forego

the growth potential of common stock, or the additional safety provided by bonds. For me, it’s a hybrid

that doesn’t belong in my portfolio.

What are the different types of stocks?There are two main types of stocks: common stock and preferred stock. Common stock is, well, common. When people talk about stocks they are usually referring to this type. In fact, the majority of stock is issued is in this form.

Do common stocks pay dividends?One way profit is distributed to the shareholders is through dividends, which are often paid in cash from the company's earnings. Dividends are usually paid on a quarterly basis. Common stockholders never know the value of their dividends in advance, while preferred stockholders receivedividends at a fixed rate.

What are stocks and shares?Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing

What is the meaning of corporate stock?The stock (also capital stock) of a corporation constitutes the equity stake of its owners. It represents the residual assets of the company that would be due to stockholders after discharge of all senior claims such as secured and unsecured debt

Watered stock is an asset with an artificially-inflated value. The term is most commonly used to refer to a form of securities fraud common under older corporate laws that placed a heavy emphasis upon the par value of stock.

What is a Preferred Stock?DEFINITION of 'Preferred Stock' A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights

What is a preference share?Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a company bankruptcy, preferred stock shareholders have a right to be paid company assets first. Preference shares typically pay a fixed dividend, whereas common stocks do not

Do preference shares have voting rights?Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. The precise details as to the structure of preferred stock is specific to each corporation.

Types

In addition to straight preferred stock, there is diversity in the preferred stock market. Additional types of

preferred stock include:

Prior preferred stock—Many companies have different issues of preferred stock outstanding at one

time; one issue is usually designated highest-priority. If the company has only enough money to meet

the dividend schedule on one of the preferred issues, it makes the payments on the prior preferred.

Therefore, prior preferreds have less credit risk than other preferred stocks (but usually offers a lower

yield).

Preference preferred stock—Ranked behind a company's prior preferred stock (on a seniority basis)

are its preference preferred issues. These issues receive preference over all other classes of the

company's preferred (except for prior preferred). If the company issues more than one issue of

preference preferred, the issues are ranked by seniority. One issue is designated first preference, the

next-senior issue is the second and so on.

Convertible preferred stock—These are preferred issues which holders can exchange for a

predetermined number of the company's common-stock shares. This exchange may occur at any

time the investor chooses, regardless of the market price of the common stock. It is a one-way deal;

one cannot convert the common stock back to preferred stock. A variant of this is the anti-dilutive

convertible preferred recently made popular by investment banker Stan Medley who structured

several variants of these preferred for some forty plus public companies. In the variants used by Stan

Medley the preferred share converts to either a percentage of the company's common shares or a

fixed dollar amount of common shares rather than a set number of shares of common.[7] The intention

is to ameliorate the bad effects investors suffer from rampant shorting and dilutive efforts on

the OTC markets.

Cumulative preferred stock—If the dividend is not paid, it will accumulate for future payment.

Exchangeable preferred stock—This type of preferred stock carries an embedded option to be

exchanged for some other security.

Participating preferred stock—These preferred issues offer holders the opportunity to receive extra

dividends if the company achieves predetermined financial goals. Investors who purchased these

stocks receive their regular dividend regardless of company performance (assuming the company

does well enough to make its annual dividend payments). If the company achieves predetermined

sales, earnings or profitability goals, the investors receive an additional dividend.

Perpetual preferred stock—This type of preferred stock has no fixed date on which invested capital

will be returned to the shareholder (although there are redemption privileges held by the corporation);

most preferred stock is issued without a redemption date.

Putable preferred stock—These issues have a "put" privilege, whereby the holder may (under certain

conditions) force the issuer to redeem shares.

Monthly income preferred stock—A combination of preferred stock and subordinated debt.

Non-cumulative preferred stock—Dividends for this type of preferred stock will not accumulate if they

are unpaid; very common in TRuPS and bank preferred stock, since under BIS rules preferred stock

must be non-cumulative if it is to be included in Tier 1 capital.[8]

Supervoting stock—a "class of stock that provides its holders with larger than proportionate voting

rights compared with another class of stock issued by the same company."[9] It enables a limited

number of stockholders to control a company. Usually, the purpose of the super voting shares is to

give key company insiders greater control over the company's voting rights, and thus its board and

corporate actions. The existence of super voting shares can also be an effective defense

against hostile takeovers, since key insiders can maintain majority voting control of their company

without actually owning more than half of the outstanding shares.[10]

Why would a stock have no par value?

People often get confused when they read about the "par value" for a stock. One reason for this is that the term has slightly different applications depending on whether you are talking about equity or debt.

In general, par value (also known as par, nominal value or face value) refers to the amount at which a security is issued or can be redeemed. For example, a bond with a par value of $1,000 can be redeemed at maturity for $1,000. This is also important for fixed-income securities such as bonds or preferred shares because interest payments are based on a percentage of par. So, an 8% bond with a par value of $1,000 would pay $80 of interest in a year.

It used to be that the par value of common stock was equal to the amount invested (as with fixed-income securities). However, today most stocks are issued with either a very low par value (such as $0.01 per share) or no par value at all.

You might be asking yourself why a company would issue shares with no par value. Corporations do this because it helps them avoid a liability to stockholders should the stock price take a turn for the worse. For example, if a stock was trading at $5 per share and the par value on the stock was $10, theoretically, the company would have a $5-per-share liability.

Par value has no relation to the market value of a stock. A no par value stock can still trade for tens or hundreds of dollars - it all depends on what the market feels the company is worth.

Par Value for Stock

Par value is the price at which a company's shares were initially offered for sale. The intent behind the par value concept was that prospective investors could be assured that an issuing company would not issue shares at a price below the par value.

DEFINITION of 'Par Value'

The face value of a bond. Par value for a share refers to the stock value stated in the corporate charter. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. Par value for a bond is typically $1,000 or $100. Shares usually have no par value or very low par value, such as 1 cent per share. The market price of a bond may be above or below par, depending on factors such as the level of interest rates and the bond’s credit status. In the case of equity, par value has very little relation to the shares' market price.

What is no par value stock?No par value stock is shares that have been issued without a par value listed on the face of the stock certificate. Historically, par value used to be the price at which a company initially sold its shares. There is a theoretical liability by a company to its shareholders if the market price of its stock falls below the par value for the difference between the market price of the stock and the par value

Companies set the par value as low as possible in order to avoid this theoretical liability. It is common to see par values set at $0.01 per share, which is the smallest unit of currency. Some states allow companies to issue shares with no par value at all, which eliminates the theoretical liability payable by the issuer to shareholders. If common stock has no par value, a company prints "no par value" on the face of any stock certificates that it issues.

When a company has no par value stock, there is effectively no minimum baseline from which to price the stock, so the price is instead determined by the amount that investors are willing to pay, based on their perceived value of the issuing entity; this may be based on a number of factors, such as cash flows, the competitiveness of the industry, and changes in technology.

When a company sells no par value stock to investors, it debits cash received, and credits the common stock account. If a company had instead sold common stock to investors that had a par value, then it would credit the common stock account up to the amount of the par value of the shares sold, and it would credit the additional paid-in capital account in the amount of any additional price paid by investors in excess of the par value of the stock.

DEFINITION of 'Voting Shares'

Shares that give the stockholder the right to vote on matters of corporate policy making as well as who will compose the members of the board of directors.

If I own a stock in a company, do I get a say in the company's operations?

You don't get a direct say in a company's day-to-day operations, but, depending on whether you own voting or non-voting stock, you may have a hand in shaping its board of directors and deciding on special issues.

Voting Stock – If the stock you own is a voting stock and you're a shareholder on record when a decision must be made through a vote, you have a right to vote on the issue. The right to vote for a member on the board of directors or on a specific business decision is similar to the right to vote for a U.S. senator or on a political issue in a plebiscite: you don't have to vote if you don't want to, and you don't really get a direct say in daily government operations (although you do vote on the people that do). The one main difference between voting as a citizen and voting as a shareholder is that if, as a shareholder, you choose not to submit your vote, there is the possibility that a default choice will be made regardless of your true desires. Be sure carefully to read the fine print on the proxy form sent to you.

Non-Voting Stock – A non-voting stock doesn't allow you to participate in votes affecting shareholders and the company. These types of shares are created so that investors who forfeit the right to have a say in the direction of the company are able to participate in the company's profitability and success.

Not all companies offer these two different types of stock, and not all types of voting stock have the same voting rights. If you are interested in playing a part (albeit a very small one) in the decision making processes of a company, make sure you buy the right type of stock.

Founders' shares

Issued to the originators of a firm, these shares (stock) normally do not receive any return until dividend payable to common stock holders (ordinary share holders) is paid out. However, these shares are entitled to all of the remaining (after tax) profits, no matter how much.

Redeemable shares.

These are shares issued on terms that the company will, or may, buy them back at some future date. The date may be fixed (e.g. that the shares will be redeemed five years after they are issued) or at the directors' discretion. The redemption price is often the same as the issue price, but need not be. This can be a way of making a clear arrangement with an outside investor.

They may also be redeemable at any time at the company's option. This often done with non-voting shares given to employees so that, if the employee leaves the company his shares can be taken back at their nominal value. There are statutory restrictions on the redemption of shares. The main requirement, like a buy-back, being that the company may only redeem the shares out of accumulated profits or the proceeds of a fresh issue of shares (unless it makes a permissible capital. Preference shares are often redeemable

What is treasury stock?

Treasury stock is a corporation's previously issued shares of stock which have been repurchased from the stockholders and the corporation has not retired the repurchased shares. The number of shares of treasury stock (or treasury shares) is the difference between the number of shares issued and the number of sharesoutstanding. Since the treasury shares result in fewer shares outstanding, there may be a slight increase in the corporation's earnings per share.

Treasury Stock is also the title of a general ledger account that will typically have a debit balance equal to the cost of the repurchased shares being held by the corporation. (Some corporations use the par value method instead.) The cost of the treasury stock purchased with cash will reduce the corporation's cash and the amount of its total stockholders' equity.

The shares of treasury stock will not receive dividends, will not have voting rights, and cannot result in an income statement gain or loss. The shares of treasury stock can be sold, retired, or could continue to be held as treasury stock.