IP No. 72 Issue Paper
IP 72–20
otherwise dictated by legal requirements, in earned surplus subject to possible further similar
stock issuances or cash distributions.
11. Where the number of additional shares issued as a stock dividend is so great that it has,
or may reasonably be expected to have, the effect of materially reducing the share market value,
the committee believes that the implications and possible constructions discussed in the
preceding paragraph are not likely to exist and that the transaction clearly partakes of the nature
of a stock split-up as defined in paragraph 2. Consequently, the committee considers that under
such circumstances there is no need to capitalize earned surplus, other than to the extent
occasioned by legal requirements. It recommends, however, that in such instances every effort
be made to avoid the use of the word dividend in related corporate resolutions, notices, and
announcements and that, in those cases where because of legal requirements this cannot be
done, the transaction be described, for example, as a split-up effected in the form of a dividend.
12. In cases of closely-held companies, it is to be presumed that the intimate knowledge of
the corporations’ affairs possessed by their shareholders would preclude any such implications
and possible constructions as are referred to in paragraph 10. In such cases, the committee
believes that considerations of public policy do not arise and that there is no need to capitalize
earned surplus other than to meet legal requirements.
13. Obviously, the point at which the relative size of the additional shares issued becomes
large enough to materially influence the unit market price of the stock will vary with individual
companies and under differing market conditions and, hence, no single percentage can be laid
down as a standard for determining when capitalization of earned surplus in excess of legal
requirements is called for and when it is not. However, on the basis of a review of market action
in the case of shares of a number of companies having relatively recent stock distributions, it
would appear that there would be few instances involving the issuance of additional shares of
less than, say, 20% or 25% of the number previously outstanding where the effect would not be
such as to call for the procedure referred to in paragraph 10.
14. The corporate accounting recommended in paragraph 10 will in many cases, probably
the majority, result in the capitalization of earned surplus in an amount in excess of that called for
by the laws of the state of incorporation; such laws generally require the capitalization only of the
par value of the shares issued, or, in the case of shares without par value, an amount usually
within the discretion of the board of directors. However, these legal requirements are, in effect,
minimum requirements and do not prevent the capitalization of a larger amount per share.
Stock Split-ups
15. Earlier in this chapter a stock split-up was defined as being confined to transactions
involving the issuance of shares, without consideration moving to the corporation, for the purpose
of effecting a reduction in the unit market price of shares of the class issued and, thus, of
obtaining wider distribution and improved marketability of the shares. Where this is clearly the
intent, no transfer from earned surplus to capital surplus or capital stock account is called for,
other than to the extent occasioned by legal requirements. It is believed, however, that few cases
will arise where the aforementioned purpose can be accomplished through an issuance of shares
which is less than, say, 20% or 25% of the previously outstanding shares.
16. The committee believes that the corporation’s representations to its shareholders as to
the nature of the issuance is one of the principal considerations in determining whether it should
be recorded as a stock dividend or a split-up. Nevertheless, it believes that the issuance of new
shares in ratios of less than, say, 20% or 25% of the previously outstanding shares, or the
frequent recurrence of issuances of shares, would destroy the presumption that transactions
represented to be split-ups should be recorded as split-ups.
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