Wednesday, February 13, 2008

The “Par” Has Lost Its Value

Indian company law includes several concepts that have become archaic. Efforts have been made to address this issue and to modernize company law – some the recent ones include a Concept Paper prepared by the Ministry of Company Affairs in 2004 and the JJ Irani Committee Report presented in 2005. However, these changes are yet to see the light of day.

This blog will periodically carry a discussion on some of the areas of Indian company law that necessitate modernization and review in the context of international practices. Some of these changes have already been contained in various recommendations to overhaul the Indian Companies Act, while others have not been addressed at all. The first among these relates to the concept of “par value” of shares.

Par value of shares (which is also commonly referred to as “nominal value”) is the minimum value or floor price at which shares can be issued by a company. While law encourages companies to issue shares at a price that is higher than the par value (the difference being known as “premium”), it abhors issue of shares are less than par value (the difference in this case being known as “discount”). Par value is a 19th century English concept that has found its way into the Indian Companies Act, 1956.

The ostensible justification for imposing par value on shares is two-fold: first, that it protects creditors a company and second, that it protects existing shareholders. Since shareholders will be obligated to bring in capital at least to the extent of the par value of the shares, it provides protection to creditors as they are able to assess the level of capitalization of a company. This would be particularly relevant where shares are partly paid, in which case shareholders would have a liability towards the company to the extent of the unpaid capital. As for existing shareholders, par value provides protection in that the company is prohibited (or substantially restrained) from issuing capital at a price less than the par value. By providing assurance of a minimum floor price on further capital issuances, it sets in place a kind of anti-dilution protection (as is currently in vogue though by contractual means).

Although par value may indeed have provided benefits to shareholders and creditors historically, its significance has eroded in modern company law. Consequently, several jurisdictions such as the United States (principally Delaware) and even Commonwealth countries such as Australia, New Zealand and Singapore (which largely drew their company law from England) have abolished par value on shares and shifted to a no-par value regime. Presently, England, several continental European countries and other countries such as India continue to follow the par value concept for issuance of shares.

Let us examine some of the adverse effects of par value. First, there is no clarity on a benchmark par value. Under the Indian Companies Act, companies are largely free to determine their own par value. In practice, the numbers range from Rs. 100 to Rs. 10 to even as low as Rs. 1 per share, depending on the nature of the company. For listed companies going for a public offering, however, SEBI does prescribe norms whereby companies will be permitted to fix low par values only if the price in the offering is above certain thresholds. Multiple par values in the markets create confusion to investors as they are unable to compare companies and their shares prices where their par values are different.

Second, since companies are largely free to fix their own par values, the protection it renders to shareholders and creditors is illusory. This is especially so when par values are so minimal as to not afford any protection at all.

Third, par value on shares introduces inflexibility in financing options for companies, especially those that are experiencing deterioration in their financial condition. Such companies may often require financial restructuring which involves induction of fresh capital at low prices. Existing law proves to be a hurdle as Section 79 of the Companies Act imposes onerous conditions (such as obtaining the approval of the Company Law Board) to issue shares at a discount, thereby making this option unviable. Par value hinders efficient restructurings or turnarounds of companies and thereby affects proper functioning of the industrial economy.

Fourth, the par value regime involves additional complexities on the accounting front. Share issuances at a premium require categorization of capital as par value and premium in the accounts and financial statements of the company. While that itself may not present significant problems, any restructuring of capital at a later stage will involve accountants having to make adjustments for both the par value and the premium. A no par value regime would be elegant in as much as it simplifies accounting matters considerably.

A no par regime will help overcome the disadvantages listed above, and allow for uniformity and homogeneity in shares of a class (all without par value). All shares will represent a proportionate part of the share capital of a company of the relevant class, and no more. The simplicity of the no par value regime outweighs the benefits of a par value regime and Indian company law ought to be move towards abolishing par value of shares.


Gauri said...

The par value als has interesting implications for listed companies/companies proposing to list.

Clause 3.7 of the DIP Guidelines have created a link between the par value and the market value, whereby the par value of a stock must not be less than Rs. 10 in the event its IPO price is contemplated to be less than Rs. 500.

In reality, this has no relevance and in fact, issuers have faced problems in the past due to this restriction.

Pramod Rao said...

Some thoughts that were expressed by Mr Warren Buffet, Chairman of Berkshire Hathaway in the Chairman's Report (of 1983) that is of relevance is set forth below:

Stock Splits and Stock Activity

We often are asked why Berkshire does not split its stock.
The assumption behind this question usually appears to be that a
split would be a pro-shareholder action. We disagree. Let me
tell you why.

One of our goals is to have Berkshire Hathaway stock sell at
a price rationally related to its intrinsic business value. (But
note “rationally related”, not “identical”: if well-regarded
companies are generally selling in the market at large discounts
from value, Berkshire might well be priced similarly.) The key to
a rational stock price is rational shareholders, both current and

If the holders of a company’s stock and/or the prospective
buyers attracted to it are prone to make irrational or emotion-
based decisions, some pretty silly stock prices are going to
appear periodically. Manic-depressive personalities produce
manic-depressive valuations. Such aberrations may help us in
buying and selling the stocks of other companies. But we think
it is in both your interest and ours to minimize their occurrence
in the market for Berkshire.

To obtain only high quality shareholders is no cinch. Mrs.
Astor could select her 400, but anyone can buy any stock.
Entering members of a shareholder “club” cannot be screened for
intellectual capacity, emotional stability, moral sensitivity or
acceptable dress. Shareholder eugenics, therefore, might appear
to be a hopeless undertaking.

In large part, however, we feel that high quality ownership
can be attracted and maintained if we consistently communicate
our business and ownership philosophy - along with no other
conflicting messages - and then let self selection follow its
course. For example, self selection will draw a far different
crowd to a musical event advertised as an opera than one
advertised as a rock concert even though anyone can buy a ticket
to either.

Through our policies and communications - our
“advertisements” - we try to attract investors who will
understand our operations, attitudes and expectations. (And,
fully as important, we try to dissuade those who won’t.) We want
those who think of themselves as business owners and invest in
companies with the intention of staying a long time. And, we
want those who keep their eyes focused on business results, not
market prices.

Investors possessing those characteristics are in a small
minority, but we have an exceptional collection of them. I
believe well over 90% - probably over 95% - of our shares are
held by those who were shareholders of Berkshire or Blue Chip
five years ago. And I would guess that over 95% of our shares
are held by investors for whom the holding is at least double the
size of their next largest. Among companies with at least
several thousand public shareholders and more than $1 billion of
market value, we are almost certainly the leader in the degree to
which our shareholders think and act like owners. Upgrading a
shareholder group that possesses these characteristics is not

Were we to split the stock or take other actions focusing on
stock price rather than business value, we would attract an
entering class of buyers inferior to the exiting class of
sellers. At $1300, there are very few investors who can’t afford
a Berkshire share. Would a potential one-share purchaser be
better off if we split 100 for 1 so he could buy 100 shares?
Those who think so and who would buy the stock because of the
split or in anticipation of one would definitely downgrade the
quality of our present shareholder group. (Could we really
improve our shareholder group by trading some of our present
clear-thinking members for impressionable new ones who,
preferring paper to value, feel wealthier with nine $10 bills
than with one $100 bill?) People who buy for non-value reasons
are likely to sell for non-value reasons. Their presence in the
picture will accentuate erratic price swings unrelated to
underlying business developments.

We will try to avoid policies that attract buyers with a
short-term focus on our stock price and try to follow policies
that attract informed long-term investors focusing on business
values. just as you purchased your Berkshire shares in a market
populated by rational informed investors, you deserve a chance to
sell - should you ever want to - in the same kind of market. We
will work to keep it in existence.

One of the ironies of the stock market is the emphasis on
activity. Brokers, using terms such as “marketability” and
“liquidity”, sing the praises of companies with high share
turnover (those who cannot fill your pocket will confidently fill
your ear). But investors should understand that what is good for
the croupier is not good for the customer. A hyperactive stock
market is the pickpocket of enterprise.

For example, consider a typical company earning, say, 12% on
equity. Assume a very high turnover rate in its shares of 100%
per year. If a purchase and sale of the stock each extract
commissions of 1% (the rate may be much higher on low-priced
stocks) and if the stock trades at book value, the owners of our
hypothetical company will pay, in aggregate, 2% of the company’s
net worth annually for the privilege of transferring ownership.
This activity does nothing for the earnings of the business, and
means that 1/6 of them are lost to the owners through the
“frictional” cost of transfer. (And this calculation does not
count option trading, which would increase frictional costs still

All that makes for a rather expensive game of musical
chairs. Can you imagine the agonized cry that would arise if a
governmental unit were to impose a new 16 2/3% tax on earnings of
corporations or investors? By market activity, investors can
impose upon themselves the equivalent of such a tax.

Days when the market trades 100 million shares (and that
kind of volume, when over-the-counter trading is included, is
today abnormally low) are a curse for owners, not a blessing -
for they mean that owners are paying twice as much to change
chairs as they are on a 50-million-share day. If 100 million-
share days persist for a year and the average cost on each
purchase and sale is 15 cents a share, the chair-changing tax for
investors in aggregate would total about $7.5 billion - an amount
roughly equal to the combined 1982 profits of Exxon, General
Motors, Mobil and Texaco, the four largest companies in the
Fortune 500.

These companies had a combined net worth of $75 billion at
yearend 1982 and accounted for over 12% of both net worth and net
income of the entire Fortune 500 list. Under our assumption
investors, in aggregate, every year forfeit all earnings from
this staggering sum of capital merely to satisfy their penchant
for “financial flip-flopping”. In addition, investment
management fees of over $2 billion annually - sums paid for
chair-changing advice - require the forfeiture by investors of
all earnings of the five largest banking organizations (Citicorp,
Bank America, Chase Manhattan, Manufacturers Hanover and J. P.
Morgan). These expensive activities may decide who eats the pie,
but they don’t enlarge it.

(We are aware of the pie-expanding argument that says that
such activities improve the rationality of the capital allocation
process. We think that this argument is specious and that, on
balance, hyperactive equity markets subvert rational capital
allocation and act as pie shrinkers. Adam Smith felt that all
noncollusive acts in a free market were guided by an invisible
hand that led an economy to maximum progress; our view is that
casino-type markets and hair-trigger investment management act as
an invisible foot that trips up and slows down a forward-moving

Contrast the hyperactive stock with Berkshire. The bid-and-
ask spread in our stock currently is about 30 points, or a little
over 2%. Depending on the size of the transaction, the
difference between proceeds received by the seller of Berkshire
and cost to the buyer may range downward from 4% (in trading
involving only a few shares) to perhaps 1 1/2% (in large trades
where negotiation can reduce both the market-maker’s spread and
the broker’s commission). Because most Berkshire shares are
traded in fairly large transactions, the spread on all trading
probably does not average more than 2%.

Meanwhile, true turnover in Berkshire stock (excluding
inter-dealer transactions, gifts and bequests) probably runs 3%
per year. Thus our owners, in aggregate, are paying perhaps
6/100 of 1% of Berkshire’s market value annually for transfer
privileges. By this very rough estimate, that’s $900,000 - not a
small cost, but far less than average. Splitting the stock would
increase that cost, downgrade the quality of our shareholder
population, and encourage a market price less consistently
related to intrinsic business value. We see no offsetting