While it may seem that the corporation laws almost without exception prohibit the issuance of full-paid shares for less than the equivalent of their par value, and that it would be impossible, therefore, for a corporation to start out with a capitalization higher than the actual market value of its property, it is well known that in actual practice this law is frequently ignored.

The capitalization of many corporations does not correspond, or even tend to correspond, closely to the value of their assets. How is it possible to introduce this overcapitalization - or "water," as it is sometimes called - without acting directly in opposition to the law? The answer is to be found in the process of placing a valuation on the property or services acquired by the corporation. It is, of course, impossible to place an overvaluation on cash payments for stock. It is difficult to place an excessive overvaluation, even if it should be desired to do so, on tangible property that is accepted in payment for stock; such property is for the most part of fairly stable and easily ascertainable value. But in the valuation of intangible property - good-will, patents, trade-marks, copyrights, organization, and the like - and in the valuation of special services, there is every opportunity to fix any figure that may be desired by the organizers of the corporation. It is not necessary to assume a wilful falsification of values in every instance in which a corporation is later shown to have been overcapitalized. Organizers are likely to be sanguine men who sincerely believe, at least for the time being, that the property they are acquiring has a remarkable potential value. By means, therefore, of the simple device of issuing stock for intangible property and services at whatever valuation the directors of a corporation agree upon, it is possible to adjust the capitalization of the corporation to suit the ideas and interests of the organizers of the corporation.

The promoter of a mining company, to imagine an extreme case, thinks it possible to sell $1,000,000 par value of stock provided he can offer it at a heavy discount, say 10 cents on the dollar. His first step after incorporating his company is to procure a piece of property that may be represented as a prospective mine. He places a valuation of $1,000,000 on this property and sells it to the corporation - the directors of which are his own "dummies" - for $1,000,000 par value in stock. The promoter is then ready to sell his stock to the public at any price he may see fit to put upon it. The stock has been made full-paid because it has been issued for property which the directors have declared to be worth $1,000-000. This assumed transaction would probably be purely fraudulent. The same principle, however, is applied in organizing many legitimate corporations.

For instance, at the inception of the United States Steel Corporation, all the preferred and common shares, as well as its 5% gold bonds, were turned ever to a syndicate of bankers headed by J. P. Morgan and Company, in exchange for $25,-000,000 in cash plus the stocks and certain bonds of the seven corporations which were at first taken into the combination. In view of the fact that some of the seven companies acquired had a considerable amount of water in their own capitalization, and inasmuch as the $1,300,000,000 stocks and bonds received by the syndicate had a much higher value than the market value of the stocks and bonds of the subsidiary companies, it is clear that the Steel Corporation started out with a large amount of water in its capitalization. The estimate of the market is shown by the fact that the common stock at first sold in the neighborhood of one-third of its par value. In this case the directors were free to place their own valuation on the securities of the subsidiary corporations which they acquired, and more especially on the services rendered by the syndicate which carried through the whole transaction.

As reference will be made from time to time in this volume to numerous other instances of overcapitalization, no further examples need be cited here. It may be remarked in passing, however, that the basic theory of the law that capitalization should always correspond to the actual market value of the assets of a corporation is, in the judgment of many competent thinkers, both impractical and unsound.

It may be asked why the courts do not more frequently enforce a closer adherence to the intent of the law. The answer has already been partly indicated. The intangible assets and the services which are accepted by corporations in payment for their stock are difficult to value, and for this reason it is only in exceptional cases that bad faith on the part of corporations in making their valuations can be conclusively shown. On the numerous occasions when this question has been involved, the courts have applied either one or the other of two rules, known respectively as the "true value" rule and the "good faith" rule. The true value rule, which has been applied in a number of instances during recent years by the courts of Maine and New Jersey, is to the effect that in case a wide discrepancy between the market value of property and the par value of shares for that property can be shown, it may be assumed that the directors were misinformed; hence the shares issued for that property are not "full-paid," and the holders of these shares may be sued for the difference between the real value of the property and the par value of the shares they received. In a New Jersey case, in which the owner of a patent had received $1,000,000 in stock for his contrivance, after the owner's death his estate was found to be liable to the corporation for approximately $900,000. The other rule, which was formerly universal in the United States and which is still commonly applied, indicates that directors may be assumed to be acting in good faith and with proper information before them unless fraud can be conclusively shown. It is well known that it is always a difficult matter to produce legal evidence of fraud.