Watered stock
The term refers to a situation in which the shares of a company are issued at a far greater price than the actual combined value of the company's underlying assets. This is a situation in which the company's stock is artificially inflated and defrauds its investors.
Ironically, the term is believed to come from ranchers, who made their kettle consume large amounts of water before weighing and selling them, so as to earn a larger profit on the sale.
There are multiple tactics companies use to inflate their stock, among them:
- Manipulating accounting values by artificially inflating factors such as inventory or property value for a one-time boost
- Engaging in excessive stock issuance through the distribution of stock dividends
- Engaging in excessive stock issuance through an employee stock-option program
This practice was largely discontinued when companies were obligated to issue shares with low or no par value, often under the guidance of attorneys who were mindful of the legal risks associated with issuing watered stock that could impose liabilities on investors. As a result, investors became cautious about relying on the par value of a stock as an accurate representation of its true value.
Consequently, accounting guidelines were established to ensure that the disparity between the asset value and the low or no par value would be recorded as capital surplus or additional paid-in capital.
