Lecture 9 - Contributed Capital

Contributed Capital

This only applies to corporations. Sole proprietorship and partnerships are easier.

Limited liability is a benefit – owner is not personally liable, encourages risk-taking, easier to raise capital by selling stock

Lack of mutual agency – in a partnership, one of the partners can obligate the partnership. In a corporation, only officers of the corporation can.

Death of a corporate owner (shareholder) does not affect the corporation.

Disadvantages include govt regulation, taxation, limited liability (may not be able to raise capital from banks due to limited liability) and separation of ownership and control (mgmt may not do what shareholders want).

Ratio Analysis

Dividend Yield = dividends per share / market price per share

Use this to compare to bank interest rate or bonds. Even if it’s less, may be ok due to appreciation of share price.

P/E Ratio = price per share / earnings per share

ROE shows how effectively company is using its assets.
ROE = net income / avg stockholders equity
ROE can be manipulated

Terminology:
Common stock par value
Common stock excess over par

Ex: issuing 100 shares at $18/share with $10 par value per share
Par value 1000
Excess over par 800

Some states have statues against paying dividends from par value.

Some financial statements don’t have a par value (if not required by the state).
Preferred stock

Always has a par value and it’s relevant. It’s an expected dividend. In some sense similar to a bond.

Its dividends are preferred before common stock holders get theirs.

Preferred stock can be non-cumulative and the amounts skipped in prior years are just gone. They can also be cumulative

Convertible preferred shares

Can be convertible from preferred to common shares

Callable preferred stock

Allows the company to buy back the preferred stock.

Treasury stock

Company buys back its stock and puts it in its “treasury”
Issued-treasury = outstanding
Why buy back?
Prevents hostile takeover
To boost earnings per share

Dr. Treasury stock
--- Cr. Cash

Shows up as a reduction of owners equity

On resale of treasury stock, no gain or loss is recognized on the purchase or sale of treasury stock.

Compensatory Stock Options

Usually issued at current market price.

Revised Fasb 123 deals with this. Either record it or put it in the footnotes. They chose to put it in footnotes, of course.

This hiding of compensation expenses and the motivating of officers to manipulate income contributed to the collapse of Enron.