What are Watered Stock
Watered stock are shares of a company that are issued at a much greater value than its underlying assets, usually as part of a scheme to defraud investors. This term is believed to have originated from ranchers who would make their cattle drink large amounts of water before taking them to market. The weight of the consumed water would make the cattle deceptively heavier, enabling the ranchers to fetch higher prices for them. The last known case of watered stock issuance occurred decades ago, as stock issuance structure and regulations have evolved to put a stop to the practice.
BREAKING DOWN Watered Stock
The book value of assets can be overvalued for several reasons, including inflated accounting values — like a one-time artificial increase in inventory or property value — or excessive issuance of stock through, for example, a stock dividend or employee stock-option program. Perhaps not in every single case, owners of a corporation would knowingly sell shares in their companies at a par value that far exceeded the book value of the underlying assets, leaving investors with a loss and the fraudulent owners with a gain. It would not be until much later that investors learned that they were deceived. Those holding watered stock found it difficult to sell their shares and if they could find buyers, the shares were sold at much lower prices than the original price.
This practice essentially came to an end when companies were compelled to issue shares at low or no par value. Investors became wary of the promise that par value of stock represented the actual value of stock. Accounting guidelines developed so that the difference between the value of assets and low or no par value would be accounted for as capital surplus or additional paid-in capital.