Share Classifications

Before diving into what common stock can do, it helps to understand how shares are categorized. Every corporation tracks its stock using a specific hierarchy that determines how many shares exist, who holds them, and how many can still be issued.

The Share Hierarchy

Think of share classifications as nested containers, where each level fits inside the one above it:

Authorized >= Issued >= Outstanding

Authorized Shares

• The maximum number of shares a corporation is permitted to issue, as specified in the corporate charter (articles of incorporation)
• A company does not have to issue all authorized shares; the charter sets the ceiling, not the floor
• Changing the number of authorized shares requires a shareholder vote and an amendment to the charter

Exam Tip: Gotchas

A company cannot issue more shares than authorized without a shareholder vote to amend the charter.

Issued Shares

• Shares that have been sold to investors at some point, whether investors still hold them or the company bought them back
• Issued shares can never exceed authorized shares
• Once a share is issued, it remains "issued" even if the company repurchases it (it becomes treasury stock)

Exam Tip: Gotchas

Issued shares include both outstanding shares AND treasury shares. Once a share has been sold to the public, it remains "issued" even after the company buys it back.

Outstanding Shares

• Shares currently held by all investors, including officers, directors, institutions, and the general public
• The critical formula:

Outstanding Shares = Issued Shares - Treasury Stock

• Outstanding shares are the denominator in key financial ratios:
  • Earnings per share (EPS) = Net Income / Outstanding Shares
  • Book value per share = Total Equity / Outstanding Shares

Exam Tip: Gotchas

Outstanding = Issued minus Treasury. EPS and book value per share are both calculated using outstanding shares, not authorized or issued.

Treasury Stock

• Previously issued shares that the corporation has repurchased on the open market
• Treasury stock is unique; it is issued but NOT outstanding

Treasury stock does NOT:

• Vote
• Receive dividends
• Get included in EPS calculations

Treasury stock CAN:

• Be reissued (sold back to the public)
• Be retired (permanently cancelled, reducing issued share count)

Why companies buy back stock:

• Reduces outstanding shares, which increases EPS and book value per share
• Signals management confidence in the company's value
• Can be used for employee stock compensation plans

Exam Tip: Gotchas

• Treasury stock is "issued" but NOT "outstanding." If a company has 10 million authorized, 8 million issued, and 1 million in treasury, it has 7 million outstanding and can still issue 2 million more new shares.
• Treasury shares do not vote and do not receive dividends.
• Retiring treasury stock reduces the issued share count; reissuing treasury stock increases outstanding shares.

Par Value and Stated Value

• Par value for common stock is typically a nominal amount (e.g., $0.01 or $1.00) and represents the minimum price at which shares can be initially issued
• Par value has no direct relationship to market price
• Stated value is an arbitrary value assigned by the board of directors when stock is issued with no par value
• Stated value serves an accounting function similar to par value

Exam Tip: Gotchas

Par value has no relationship to market value. A common stock with $0.01 par value can trade at $500 per share. Par value is an accounting convention, not a valuation.

Putting It All Together

Here's a practical example to cement the relationships:

• The company can issue up to 2 million NEW shares without a shareholder vote
• The company can also reissue the 1 million treasury shares
• EPS and book value per share are calculated using 7 million outstanding shares