Authorized Shares

Authorized shares limit the number of shares that a company can issue. It is mentioned in the article of incorporation. Usually, companies set a higher limit right from the start. Then, any consecutive increase is put to the vote. This cap prevents existing shareholders' holdings from being too diluted.

A limit on authorized shares keeps the power struggle between the shareholders and management in check, especially during mergers. If the number of authorized stocks is too high, the board of directors becomes too powerful. In such scenarios, the target firm management can initiate defensive strategies against hostile takeovers.

• Authorized shares limit the number of shares that a company can issue. It is mentioned in the company’s article of incorporation.
• The corporate charter must contain information about classes of shares and the maximum number for each class.
• If more than one share class is permitted, the article of incorporation must specify distinguishing designation for each class.
• To increase the number of authorized stocks, the firm requires consent from the company shareholders. This change requires majority approval—at least two-thirds must favor this move.

Authorized shares restrict the maximum number of shares a company can issue without shareholder approval. This number is mentioned in the corporate charter. In the short term, a company’s stock sale cannot surpass authorized stocks.

Before venturing further, let us quickly define a share. A company issues ordinary shares to raise funds from public and private investors. They carry voting rights. They are also called common shares; they represent an investor's equity. An investor’s equity or ownership in a company is proportionate to the number of ordinary shares. Shareholders do not receive a dividend by default.

The article of incorporation (also known as corporate charter) contains details about the class of shares and the maximum number of shares issued (for each class). If more than one share class is permitted, the article of incorporation must specify it clearly; so that the designation for each class can be distinguished.

The article of incorporation authorizes the following:

• One or more classes of shares collectively with unlimited voting rights.
• One or more share classes, which may be the same class or classes of shares with voting rights, that collectively are eligible to receive net assets upon dissolution.

The article of incorporation is a legal document submitted to the government. This document is required when a business registers as a corporation or non-profit organization. This document contains the company's name, type, nature, address, and number of authorized stocks.

Authorized stocks restrict the number of shares a company can issue without permission (from shareholders). Increasing this number is a tedious process; the firm drafts a proxy, the proposal is reviewed by the SEC, and the charter undergoes several changes. In addition, the firm requires the approval of majority shareholders (two-thirds). And this process can take several months. If successful, a shareholder's meeting is scheduled. Sometimes, it is conducted to discuss the increase in shares.

Limiting authorized share capital balances the power struggle between the company's management and its shareholders. This is especially crucial during a merger or tender. In hostile takeovers, target firm management could engage in certain defensive strategies. The poison pill is one such strategy. Firm owners use the poison pill to deter unwelcome investors, rivals, or potential buyers from acquiring a controlling stake in the business.

Alternatively, the target management could offer a top-up option to the acquirers to speed the deal completion (hostile takeovers). When the target company speeds up the process, it discourages competing bids. In both strategies, the target firm requires unissued authorized shares in excess.

Thus, the Board of Directors does not need shareholder approval if a company possesses enough shares. On the other end of the spectrum, limiting the authorized shares prevents unfair practices (curtails the board's decision-making ability).

Let us discuss how to calculate authorized shares.

In most cases, the number of issued stocks is considerably fewer than that of authorized stocks. Here, the number of issues stocks refers to shares sold by the firm to shareholders.

Authorized stocks also comprise shares issued to the public.  Thus, the following formula is used for calculation:

• Authorized Shares = Shares Issued + Yet to be Issued Shares

Let us look at authorized shares vs issued shares vs outstanding shares comparisons to distinguish between them:

This article has been a guide to what are Authorized Shares. We compare them with issued and outstanding shares and explain how to calculate them. You can learn more about it from the following articles –

• Transfer of Shares
• How To Buy Shares?
• Ordinary Shares Capital