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Analysis of the Introduction of Non-denominated shares

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Abstract

With the enactment of the Company Law (Amendment) Act 2021 and the public consultation, the authorized capital system began to be accepted by our company law. Closely related to it, the system of non-denominated shares was also confirmed in the draft. For a long time, China has been practicing the par value share system, which undoubtedly played a role in safeguarding the equal capital contribution relationship among shareholders, preventing the company from improperly distributing dividends, protecting the company’s continuous operation and being solvent under the framework of the early company law theory. However, with the development of the market and corporate governance, the actual function of the par value share system seems to be gradually deviated from the original purpose of its establishment. The purpose of this paper is to demonstrate the advantages of implementing a system of non-denominated shares, and also to suggest some supporting institutional arrangements after the introduction of non-denominated shares.
duannan525
@p
ku.edu.cn
Analysis of the Introduction of Non-denominated shares
Nan Duan
Peking University Law School
Abstract. With the enactment of the Company Law (Amendment) Act 2021 and the public consultation, the
authorized capital system began to be accepted by our company law. Closely related to it, the system of non-
denominated shares was also confirmed in the draft. For a long time, China has been practicing the par value
share system, which undoubtedly played a role in safeguarding the equal capital contribution relationship
among shareholders, preventing the company from improperly distributing dividends, protecting the
company's continuous operation and being solvent under the framework of the early company law theory.
However, with the development of the market and corporate governance, the actual function of the par value
share system seems to be gradually deviated from the original purpose of its establishment. The purpose of
this paper is to demonstrate the advantages of implementing a system of non-denominated shares, and also to
suggest some supporting institutional arrangements after the introduction of non-denominated shares.
1 Introduction
According to United States Securities and Exchange
Commission (SEC) regulations, a non-denominated share
is a stock that does not contain a dollar amount on the face
of the stock, but only the number of shares or the
percentage of the total share capital. They are denoted as
"1 share", "10 shares" or "10,000 shares". The value of a
share varies according to the net worth of the issuing
company and increases when the net worth of the issuing
company increases and decreases when the net worth of
the issuing company increases. The issue price per share
is multiplied by the number of shares issued, which is the
total amount of the issue.
The denomination of shares is the basic unit of the
company's capital, so this is the starting point to see the
change and development of the company's capital system
from traditional to modern. The denomination of shares
was initially considered to be a measure of the adequacy
of the company's capital, the fairness of the share
consideration, and the appropriateness of the dividend
distribution. In the course of the company's development,
the denomination shares also initially assumed the
important function of creditor protection.
As the system and practice of corporate capital evolved,
discounted issues were no longer prohibited by law across
the board, and low-denomination shares, or even no-
denomination shares, became an alternative arrangement.
The system of issuing shares without par value originally
originated in the U.S. In the early 20th century, as the role
of the market became increasingly prominent in economic
development, market autonomy, freedom of corporate
operations, ease of financing, and maximization of
efficiency became increasingly sought after by companies.
In response to these market changes, and guided by the
judicial spirit of experience over logic, the state of New
York was the first to pass a law in 1912 allowing the
issuance of par value stock, and in 1979, the Model
Corporation Act (RMBCA) was amended to abandon
concepts such as par value and legal capital. In 1923, 24
states in the United States already allowed the issuance of
non-denominated shares. Later, other states in the U.S. and
some countries, including Germany and Japan, followed
this system. The function of the traditional denomination
system is constantly being questioned and challenged,
while the denomination-free system has been increasingly
accepted by countries as a new way of thinking about
corporate finance and an innovative move in financing
channels.
In contrast to the trend toward a faceless system, there
are many countries in the world where corporate law does
not permit the issuance of faceless shares. This of course
has the consideration of the company capital maintenance
system; but at the same time, it has also caused some
obstacles to the company financing. How to reform the
system of stock par value, so that it is in line with the basic
idea of reforming China's corporate capital system from
capital credit to asset credit and from authorized capital to
authorized capital, has become an issue that needs to be
explored.
Since the system of non-denominated shares originally
began in the United States, the author begins his
discussion of the emergence and development of the stock
denomination system with the development of the U.S.
corporate system as the center of his discussion of early
corporate law theory.
© The Authors, published by EDP Sciences. This is an open access article distributed under the terms of the Creative Commons Attribution License 4.0
(http://creativecommons.org/licenses/by/4.0/).
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2 Stock Denomination System Under
the Early Corporate Law Theory
Under the corporate system, there is often an antagonistic
relationship between the interests of creditors and
shareholders of the company. This dichotomy is reflected
in the fact that, on the one hand, the company's creditors
want the company to have large assets and not to create
new claims on its limited assets; that the shareholders
cannot receive any return on their investment until they
are paid; and that they want to be protected in all aspects
of their property against the shareholders. On the other
hand, the shareholder of the company wants to invest as
little as possible in the company's assets and to incur more
liabilities in order to obtain leverage; to be paid for the
period while the company is profitable; to be given more
freedom in terms of distribution. At the same time, for
other shareholders, he wants every other shareholder to
invest in the company in relation to the shares he has
acquired.
The legal capital system of the American corporation
in the 19th century was created to deal with this conflicting
set of problems. Of course, although the original intention,
but with the development of history, its function has also
produced some changes, and has not been adhered to in
the subsequent judicial and legislative process. The author
will discuss its abandonment and development later.
2.1 The three main functions of the early
denomination stock system
2.1.1 Protecting the company's continuous
operation and solvency.
The par value of the stock was considered to be the
protection of the solvency of the company. For this reason,
early corporate legislation strictly prohibited the issuance
of shares at a discount, and in 1892 Lord Halsbury, the
British Lord Chancellor, stated in his judgment that the
law should not allow external issues below par value per
share because, first, every creditor of a company has the
right to consider the definite and unchanging amount of
capital as its security; second, a company misleading
potential shareholders and creditors about the true amount
of its capital should not be allowed. Second, it is
impermissible for a company to mislead potential
shareholders and creditors about the true amount of its
capital.1. When the par value of the shares is clearly stated
on the face of the certificate, all shares have been issued
and fully paid up, creditors can have good reason to
believe that the stated capital of the company is the sum of
the par value of its outstanding certificates. In this sense,
the stated capital of the company serves as a reliable
guarantee for the company's creditors and holders of
senior securities, which allows creditors to rationally
judge the risk of borrowing.2
1 Eilis Ferran: Company Law and Corporate Finance, Oxford
University Press, 1999, at 355-372.
2.1.2 The yardstick for judging the fairness of the
consideration of capital contribution among
shareholders.
When a company is first established, shareholders will use
different types of property to make their contributions.
This makes it a difficult issue to compare the fairness of
different types of property contributions. The stock
denomination system that emerged from this is a fairer
reflection of the fairness of contributions among
shareholders: the stock denomination is used as a
measuring stick, and contributions are considered fair as
long as the final contribution is the same, regardless of the
form of contribution. Under a strict par value system, any
payment of consideration below the par value of the shares
is considered a fraud on the company's external creditors,
senior security holders and other shareholders, and the
shares received by the shareholder are considered to be
"watered down", thus triggering the shareholder's liability
for compensation or damages.
2.1.3 Prevent improper distribution of dividends by
the company.
Early corporate law theory held that external creditors and
holders of senior securities of the company could rely on
the capital of the initial investment, which is the capital
that invested by the company’s funder. And they could
reasonably rely on the fact that the company could not
make distributions to shareholders unless there were
profits in excess of the company's share capital, which
would trigger an improper outflow of corporate funds and
erode the interests of the company's creditors. Therefore,
the sum of the par value of all shares issued by the
company can be used as a yardstick to prevent the outflow
of the company's capital.
As the above discussion progresses, we can understand
that the expected function of stock denomination was an
unquestionable concept in the early 19th century corporate
law theory. However, with the development of modern
business society, the modern credit investigation and
remedy mechanisms, the need for efficiency in corporate
financing, the questioning of the function of minimum
corporate capital, and the change of concepts and rules
from capital credit to asset credit, the three major functions
of par value shares introduced above have been defeated
one by one.
2.2 Deviation from the function of the
denomination stock system in the development
of practice
2.2.1 Gradual deviation of the function of the
denomination system.
The three reasons for the choice of the denomination
system in early corporate law were explored above, but
with the creation of modern economic mechanisms such
2 Liu Lian Yu, "Research on the Theory and Judgment of
Company Law", Law Press, 2002, pp. 170-171.
2
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as modern credit and relief mechanisms, these three
functions are no longer important and have even become
alienated.
1. Creditor protection function: weakening.
Modern credit investigation and remedy mechanisms
have been improved, and credit investigation methods in
the modern business world have improved the initial,
simplistic, static equity-as-trust model for corporate
creditors to assess the creditworthiness of counterparties.
It allows creditors to focus more on the company's assets
rather than its capital. This is because the initial capital
credit system has continuously shown its limitations and
drawbacks.
The core of the capital credit system lies in the three
principles of "capital certainty, capital maintenance and
capital invariance". Under these three principles,
mandatory capital arrangements have become the norm.
The original purpose of denominated shares was to
determine the total amount of capital a company had, so
that creditors could decide whether to borrow from the
company. However, the capital of a company is an abstra ct
number derived by multiplying the number of shares
issued by the par value of each share, not the actual assets
owned by the company. Only under the original model we
discussed above can a company's capital and assets be
equated - but only for a moment; once the company is in
business, it is difficult to establish this relationship again.
So, in this sense, we can understand the capital credit
system as a definite, static description of the company's
capital, but in fact the disconnect between the company's
assets and capital is a constant state. What creditors are
really concerned about is the real assets owned by the
company, not the abstract number of capitals.
Thus, from a dynamic point of view, the capital credit
system that underpins the denominated stock system is
actually becoming less and less protective of creditors;
unfortunately, it is running completely counter to the
original purpose for which it arose.
2. Equal protection function of shareholders' capital
contribution: lack of substantial guarantee.
Another function of the denomination system is to
reconcile the equal contribution relationship between
shareholders. However, in Handley v. Stuts, described
above, the U.S. Supreme Court has in fact rejected a strict
par value system for stock. This attitude has been upheld
in subsequent U.S. legislation and practice. In fact, the
existence of a par value of stock not only does not provide
a substantial guarantee of equal treatment to shareholders,
but also gives a misleading illusion of equal treatment to
shareholders and potential investors.
The development of the modern business reality
society has made it increasingly thirsty for the efficiency
of corporate financing. The problem brought by the
efficiency of the company is that the premium issue
becomes a popular way of financing; at the same time, the
discount issue becomes an exceptional channel for loss-
3Fu Dou, "The Debate of Stock Denomination Trade-off",
Comparative Law Research, No. 6, 2004.
making companies thirsting for financing. Both premium
and discount offerings break through the mechanism of the
original coupon rule. In both cases, the shareholders
receive different share consideration among themselves,
so there is still a need for a path to unfair damage remedy
against this purchase price in fact, in addition to the
coupon system itself.
At the same time, the setting of the minimum capital
contribution does not serve the function of efficient
protection of equal capital contribution of shareholders of
the company as desired by the early company law theory.
Under the denominated share system out of prudence of
the company's capital, the law mostly stipulates the
minimum amount of capital for company formation. The
minimum capital system was originally arranged to
respond to the limited liability company shareholders
limited liability and raised the issue of externalities.
However, in practice, the minimum amount of capital
required for the establishment of a company, although it
can play a role in providing protection for creditors, but
otherwise this system is not useful; this system is even the
least efficient system to protect creditors.
3. Function to prevent improper dividend distribution:
difficult to use as a useful yardstick.
In the early conception of corporate law, the total face
value of the external shares issued by the company was
able to guard against the outflow of funds triggered by the
distribution of dividends in other forms3 .
In principle, the share capital of the company, which is
formed by the par value, is hardly a useful yardstick for
the distribution of the company. This is because the so-
called "capital credit" has been gradually replaced by the
concept and rules of "asset credit". It has become clear that
it is not the static equity or equity premium account figures
on the right side of the balance sheet that provide
protection to shareholders or creditors, but the ability of
the company to service its debts. The solvency of the
company has also become the yardstick for measuring the
reasonableness of the company's distribution.
This concept is also found in the practice of some
legislation: the California State Corporation Law in the
United States amended the corporate distribution scale,
using the "dual scale of assets and liabilities and solvency"
judgment, the legislator is more concerned about the
ability of the enterprise to readily liquidate funds to repay.
From this point of view, the par value is not even a
consideration for the equity premium, and therefore in
principle cannot serve as a useful yardstick for corporate
distributions, let alone be able to prevent improper
distributions of corporate dividends.
3
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2.3 Advantages of the non-denominated share
system
2.3.1 Flexibility in issue pricing: protection of
shareholders' equal rights and interests in capital
contribution.
In discussing this section, our question is whether, in
contrast to denominated shares, non-denominated shares
can serve to protect the equal interests of shareholders?
The answer is yes. The following section will focus on this
question.
1. Are the interests of shareholders really equal under the
par value share system?.
The shareholder interest shown on a par value share is
only a formal equality. It reflects the number of
shareholders who have invested the amount of money
stated on the par value for the company. However, it does
not take into account the fluidity and changeability of
corporate governance. That is, in the process of corporate
governance there is always a need for financing of one
kind or another, and the floating of the market does not
allow the stock price to be the same when the company
has a need for financing as when it was issued. This
undoubtedly brings pressure on the company's financing,
when the company has no new investors, and the
company's operation is difficult to continue, so also insist
on the equality of the ticket, the interests of shareholders
and the company are harmed.
2. No denomination shares and low denomination shares.
A denomination-free stock is one in which the face of
the stock states the proportion of the company's assets
represented by the shares represented by the stock rather
than the denomination of the stock. For purely non-
denominated shares, the company's articles of
incorporation do not specify the issue price of the
company's shares, truly making the shares non-
denominated and non-current. The determination of the
par value price of the stock is authorized by the company's
bylaws to be determined by the company's board of
directors in accordance with market conditions and the
company's own financing needs.
Although the United States affirmed the existence of
non-denominated shares by legislation as early as the
beginning of the twentieth century, whether or not to issue
non-denominated shares is a business judgment of the
company and is not mandatory in legislation. In fact, no-
denomination shares have not gained an overwhelming
advantage in this area, and denominated shares remain the
more dominant choice, with lower denomination shares
always occupying a more dominant position.
Meanwhile, let's return to the Handley v. Stuts case
discussed above. If the par value of the stock had been set
very low from the beginning, wouldn't the case have gone
so far as to have the court determine a so-called "pass"?
At the same time, in the case of shareholders'
contributions in kind or in money, it is easy to issue shares
at a price lower than the minimum price or par value set in
the articles of incorporation, also known as a "discounted
issue". Although a discounted issue can attract a
significant number of investors in a short period of time,
from a long-term perspective, a low issue price often
means that the company's business situation is not
optimistic, making the company's capital is not sufficient,
which leads to the circulation of the issued shares on the
market price decline, to the detriment of the interests of
the original shareholders.
The discounted issue makes the company's paid-in
capital less than the issued capital, and is therefore also
called "watered down shares". The "watering down" of the
company's capital can easily cause misunderstanding
between potential investors and creditors of the company,
and is not conducive to the protection of the company's
creditors. Therefore, the issuance of low-denomination
shares can prevent stock "watering", that is, the amount of
shares is very low, so that the sale price of the shares will
be much higher than the face value of the shares, the face
amount of the shares is much lower than the true market
price per share, so as to prevent the purpose of watering.
This, in fact, coincides with the function of the no-
denomination stock system.
3. Non-denominated shares can reconcile the interests of
shareholders.
As early as the early 20th century U.S. scholars had
reached some basic consensus on the advantages of non-
denominated shares over denominated shares. No-par was
not an instrument of fraud, and par was in fact irrelevant
to the value of the company. At the same time, they argued
that there were several advantages of no-par shares.
First, in law, the essence of equity is actually a
proportional interest; in the valuation of the company, it
should return to the essence of the company's profitability.
While the value of the non-denominated shares changes
with the profitability of the company, the issuance of non-
denominated shares can prompt investors and creditors of
the company to give the laws of the market and not just
the par value to make investment judgments.
Second, the hypothesis that the denomination of shares
weakens the role of the denomination and that the share
capital no longer has a protective function for creditors
and shareholders is proven to be unfounded by the
denomination of shares. In particular, they play an
important role in the reconciliation of relations between
shareholders: not only do they not give rise to shareholder
fraud, but they also make it possible to achieve substantial
equality in shareholder contributions because of the
flexibility of their issuance.
The biggest challenge to the no-money shares is
undoubtedly that they will encourage the legalization of
"watered-down shares", which will lead to inequality of
rights among shareholders and fraud among shareholders.
However, this argument is not tenable.
First, the definition of a watered-down share. It means
that there is no actual consideration paid for some shares
at the time of the shareholder's contribution. For this
"actual full consideration" how to identify, there are
different standards: par value standard, that is, when the
advanced or other property paid to the company does not
reach the par value of the shares, the shares are considered
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"watered down;" equity standard, that is, watered down
shares means that the company's books show The capital
of the company is higher than the total value of the
company's contribution actually received; the issue price
standard, that is, not all of the consideration paid, even if
it has exceeded the par value is considered watered down;
non-cash contribution for the price standard, that is, non-
cash contribution for the price standard. Therefore, if it is
said that the non-denominated shares have legalized the
adulterated shares, then it is considered that the criterion
for determining the adulterated shares is the "par value
criterion", and this conclusion is only valid on the par
value criterion; therefore, it is not valid to say that it causes
fraud among shareholders.
Moreover, there is a unique flexibility in the issuance
of non-denominated shares. This flexibility is reflected in
the fact that the price of the issue of non-denominated
shares is generally determined by the directors of the
company; although shareholders are not required to
contribute a fixed minimum amount of capital, they are
still required to contribute the same type of consideration
for the value of the denominated shares. In this sense, each
contributor's contribution is still equal. When non-
denominated shares are issued at different prices,
subscribers and holders of the same class and different
classes of shares can participate equally in equity swaps
and dividend distributions, and in this sense, the rights of
each shareholder are also equal.
Because of this, the issuance of non-denominated
shares does not harm the equal interests among
shareholders, but rather reconciles them based on market
changes and corporate governance.
2.4 Truly reflect the value of the company and
reduce misleading to investors.
Unmarked shares can truly reflect the value of the
company and reduce misleading to investors. The reasons
are as follows.
First, to some extent, no-denomination stocks can
facilitate the financing of other portfolio capital and
provide financing for companies in financial distress,
which is the biggest difference between no-denomination
stocks and par value stocks4 . The "adoption of a par
value system ......" can "keep the board of directors in
check and restrict them from issuing shares at a
discount ...... but, in the face of falling below par the
locked-in lower limit on the par value of the stock
becomes an obstacle and a bar to the company's external
financing." 5This facility was also confirmed by the U.S.
courts in the Handley case mentioned above.
Second, shares have no nominal value, so investors
will not be able to associate dividends with the nominal
capital of the company, avoiding potential
misunderstandings or misinformation. "The purpose of the
reform to introduce denomination-free shares is not to
seek to reveal which 'share' scale of value is more realistic,
4 See note [2] above.
5 W.Y. Wang and R.K. Lin, "A Study of the Corporate Capital
System and the Denomination of Stock", Yueh-Dan Law
Journal, No. 73.
but rather to eliminate the misleading value of 'shares'
from the current denomination. "6
Finally, the pricing mechanism of the non-
denominated shares determines that their issue price is
closer to the true market value of each company share they
represent. This is because, in determining the price of a
stock issue, the board of directors needs to make a decision
based on specific rules of business judgment, which means
that the board needs to take into account factors such as
maximizing the company's interests and the liquidity of
the stock. When the total value of the company's assets
changes in response to market changes, operating profit
and loss, etc., the stock price is able to change flexibly in
response to changes in the actual price of the company,
and the stock price changes more in line with the laws of
the market and the true market value of the company.
3 Conclusion
From the history of the creation and development of the
stock denomination system, the creation of the corporate
capital system was initially based on the conflicting
interests between the creditors and shareholders of the
company. The choice of legal values in different legal
systems has created different corporate capital systems,
and they have evolved with the development of practice.
Compared with the traditional authorized capital system,
our legislation accepts the authorized capital system and
the faceless share system, which can reflect the company's
real assets dynamically and is more conducive to the
company's financing, in line with the law of market
economy development. However, there are certain
shortcomings of the faceless shares themselves, and
therefore need relevant institutional arrangements to
resolve them.
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A Brief Analysis of the Issue of Stock Denomination
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Tian Juying, "A Brief Analysis of the Issue of Stock Denomination," Journal of Adult Higher Education, No. 2, 2006.
A Treatise on Corporate Law
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Shi Tiantao, A Treatise on Corporate Law, Beijing: Law Publishing House, 2006 edition.
The Commercial Code of Japan
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Wang Shujiang, et al., The Commercial Code of Japan, Beijing: China Legal Publishing House, 2000.
Rethinking the Principles of Corporate Capitalism
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Fu Dou: Rethinking the Principles of Corporate Capitalism, Beijing: Law Press, 2004.
Latest Japanese Corporate Law
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Wu Jianbin, "Latest Japanese Corporate Law", Beijing: Renmin University of China Press, 2003 edition.
Selected U.S. Corporate Regulations
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Yu Zhengping, "Selected U.S. Corporate Regulations", Beijing: Commercial Press, 1st edition, 2004
Research on the Reform of Corporate Capital System
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Zhao Xudong: "Research on the Reform of Corporate Capital System", Beijing: Law Publishing House, 2005 edition.
Legal Liability of Capital under the Change of Capital System A Rational Interpretation of the Revision of the Company Law
  • Zhao Xudong
Zhao Xudong, "Legal Liability of Capital under the Change of Capital System -A Rational Interpretation of the Revision of the Company Law," Legal Studies, September 2014.
Re-discussing the Function and Introduction of Denominationless Stocks
  • Lin Kai
Lin, Kai, "Re-discussing the Function and Introduction of Denominationless Stocks," Times Jurisprudence, December 2021.