LDM | Risk Management

Par Value

Par value is the notional face value of the shares which a company issues to investors. Nepalese listed companies have issued shares at uniform par value of Rs. 100 as per the provisions laid down in the company act earlier although as per the provisions of existing company act (Company Act 2006) the face value of shares of a public company could be minimum fifty rupees per share or equivalent to such amount exceeding fifty rupees as is divisible by the figure ten.

A company can issue shares above par value, which means at a premium, if it meets the profitability and net-worth criteria laid down in the Company Act 2006. If a company issues shares above the par value, the issue price above the par value is credited to the share premium account. In the absence of the concept of par value there would not have been the concept of share premium account.

Market Value

Market value of a share is mostly different from par value. The market value of a company’s share is the price that is quoted in the stock exchange where the shares of the company are listed. The shares of a company can be listed in the stock exchange after issue of shares to the public. Once the listing is done, the shares become available for buying and selling at the stock exchange. The buying and selling rates are determined by a number of factors, such as the profitability of the company, its profit potential, the number of shares outstanding, general market fancy for such shares, and certain other intangible factors. The market price of the shares indicates the price at which the shares of the company can be bought or sold at the capital market.

Book Value

Another concept close to the par value of shares is book value of shares. The book value of the shares of a company refers to the value of own funds for each share of the company. Book value per share of a company can be derived by adding up all the reserves and surpluses with the share capital and then dividing the resulting figure by the number of equity shares outstanding. The justification behind adding reserves to the shareholders’ capital for computing the book value is that the reserves are profits of the company, which belong to the shareholders. However, the company has decided to plough back the amount into the business. Both the book value and par value are accounting concepts.

Book Value: a Backward-looking Measure

Book value is a backward-looking measure.  It tells us how much capital the firm has raised from shareholders in the past.  It does not measure the value that shareholders place on those shares today.  The market value of the firm is forward looking; it depends on the future dividends that shareholders expect to receive. The future expected dividend depends on the revenue generating capacity, or to the economic value or future potential of the company.

Determinant of Market Value

The market value of shares can be more or less than the par value and book value. The current market value of a share can be defined as the present value of future cash streams i.e., the intrinsic value of a share is equal to the present value of the benefit associated with it which is justified by the assets, earning power, dividend policy, company prospects and the competitive advantage created by the company. The market value is also determined by culmination of the demand and supply position of the shares in the inefficient market. The par value and book value of the shares would also be some of the factors taken into account by the market in arriving at the price.

It may also be possible the market price to be less than the par value and book value if the net perception in the market is that the company may not have growth potential in future and that it is likely to perform worse than it is doing at present. Sometimes, a company may be performing steadily and having a fair book value. However, because of the stagnation of growth possibilities or the imminent force of competition or other factors affecting its future chances, the market might have viewed the share in poor light. If so, we can have instances where the market value is less than the book value.

Dividend is Declared on Par Value

One interesting thing about the dividend declaration by the company is that it is always declared on the par value of shares. Dividend is paid to the shareholders for the money invested by them in the company. A company uses not only the amount of share capital brought in by the shareholders but also the retained earnings belonging to them in the business. Therefore, paying dividend based on the amount of share capital seems to be puzzling. For example, Nepal Bank Limited (NBL) has book value per share of Rs. 298 and Standard Chartered Bank (SCB) has book value per share of Rs. 186 in 2018/019. NBL and SCB declare a dividend of 25% and 22.5% respectively on their par value for the same year. Does this mean that higher dividend on par value of share declared by NBL reflect a better corporate performance? The answer is definitely no.

Limitation of Par Value

Par value of stock does not reflect the worth of investment made by the shareholders in the company. It reflects only the true amount of paid-up capital of the company. Par value of share fails to reflect the money sacrificed by the shareholders to increase the business of the company. It is interesting to note that when retained earnings of the company remains in form of reserves and surplus it does not affect the paid-up capital. But when bonus shares are declared to the shareholders out of the same retained earnings it increases the amount of paid-up capital of the company.

Conclusion

The uniform par value concept of shares cannot be used as criteria for comparing the shares of companies. Companies having uniform par value may have different book value and market value. It is because par value has no relationship with the market value. Market value of a share is not guided by its par value; it is guided by the fundamentals of capital market in the efficient capital market. In the Nepalese context, the market value of shares is highly influenced by the speculative activity and the theory of demand and supply.