Watered stocks are basically stocks that offered to the public far greater than their true value. The term ‘watering down stocks in the stock market’ means to offer the public with such kind of stocks that are artificially inflated (Investopedia). The term originated during the nineteenth century to specify cattle that were bloated with water before they were sold so as to make them look fat and attractive (Tatum). Companies ‘water’ their stocks by over valuing their assets, which can be done by using inflated accounted methods or by issuing excessive stock (Powers).
As watering stock gets additional capital, it may be done to finance a merger, or to build a new plant etc. in this way it is advantageous to the company. It may also appear advantageous to an investor as watered stocks seem to be offering a better return (Tatum). However, it is an illegal practice as it aims to fool the public. A company, if found guilty, may be punished by revoking its charter (LeFavre). A watered stock is a disadvantage to the investors as they’re not getting the real value. If the company goes bankrupt then they will lose the capital that they invested.
In some cases, it may be a disadvantage to the company issuing such stocks as in the long run it may cause low levels of liquidity (Parish). If the investors and analysts figure out that the stock is watered then it may lead to inadequate return on capital and low market value (Hake). In fact if some one is able to prove that the management of a company has issued such stocks, its charter can be revoked (Sears). This way it can put a company in full jeopardy.
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Hake, Eric. “The Stock Watering Debate: More Light, Less Heat. ” Journal of Economic Issues (2001): 104-107. Investopedia: Watered Stock.29 May 2009 <http://www. investopedia. com/terms/w/wateredstock. asp>. LeFavre, David. Stock Watering: Judicial Valuation of Property for Stock Issue Purposes. Columbia University Press, 1930 Parish, Bill. “Watered Stock Woes. ” 21 December 2000. Philadelphia Citypaper. 29 May 2009 <http://flirt. citypaper. net/articles/122100/sl. slant. shtml>. Powers, Orville Marcellus. Commerce and Finance. California: Powers & Lyons, 1903 Sears, Brian. “Auditing Business Ethics. ” Internal Auditor (1993): 164-167. Tatum, Malcom. What is Watered Stock? 29 May 2009 <http://www. wisegeek. com/what-is-a-watered-stock. htm>.
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