Reverse stock splits don't affect the number of authorized shares, but a forward stock split issues new stock from the company's authorized shares. When new shares are issued by a company, it adds to the number of outstanding shares and reduces each shareholder's percentage of ownership in the company. This is called dilution, and it reduces the value of each share. Authorized shares represent a potential for stock dilution.
When a company incorporates, among the things the owners of the company decide is how many shares to authorize. Authorized shares are the total number of shares of each class of stock that the company has available to issue. If company management wants to increase the number of authorized shares, it must obtain the approval of the shareholders via a formal vote. Stock splits affect only the issued and outstanding stock -- the authorized shares don't split.
The board of directors decides when to dip into the authorized shares to issue new stock, and when those shares are issued, they are called issued and outstanding stock. A forward stock split increases the total number of shares issued and outstanding. For example, when the company conducts a 2-for-1 forward split, it doubles its issued shares, taking those additional shares out of the amount of authorized shares. If the forward split results in more stock issued than is available in authorized shares, the board holds a vote of the stockholders to authorize more shares. If a company has 100 million shares authorized and 75 million shares issued and outstanding, shareholders must authorize an additional 25 million shares for the company to legally issue a 2-for-1 forward split.
Reverse Stock Splits
A reverse stock split diminishes the total number of issued and outstanding shares of a company's stock, but it does not affect a shareholder's percentage ownership of the company. Because the shares have been previously issued, it does not affect or add back shares to the number of authorized shares; it simply condenses the number of issued and outstanding shares. An example of a reverse stock split would be a 1-for-50 split in which the stockholder exchanges 50 shares of pre-split stock and receives one share of new stock in return.
Share Value and Dilution
The number of issued and outstanding shares vs. the number of authorized shares is important to the market value of a stock. The issuance and sale of new stock, forward splits and stock dividends all increase the number of issued and outstanding shares and dilute stockholders' percentage ownership. More shares lower the market price per share. Fewer outstanding shares, resulting from a reverse split, increases the market price per share, and the stockholders' percentage ownership remains unchanged.
Video of the Day
- Goodshoot/Goodshoot/Getty Images