Authorized stock represents the number of equity shares that a publicly traded company is legally permitted to sell or issue in the financial markets. A company's article of incorporation documents, which are filed when a business entity is formed in the region where the headquarters are located, establishes the amount of authorized stock that may be issued. This amount is not impermeable and may be adjusted with the support of a company's board of directors and common shareholders.
There are two types of authorized stocks: common stock and preferred. Common shares provide investors with an opportunity to vote when the company faces a major decision, such as a merger or a change in executive leadership. Preferred shareholders are not offered votes, but can rely on a steady stream of income generated from quarterly and yearly dividend payment distributions. Both types of stockholders have a vested interest in the number of authorized shares that a company trades.
Stock is sold in the public markets as a means for companies to raise capital from investors for some type of growth initiative, such as an expansion. A company may opt to issue all of its authorized stock when it has its initial public offering (IPO), which represents the debut trading session in the public markets. The other alternative is to reserve some of the shares in a company's treasury and issue them in the public markets at another date.
A stock offering subsequent to an IPO is known as a secondary or follow-on offering. By reserving authorized shares after an IPO, a company is providing itself the opportunity to further tap into the capital markets in the future, even without the support of its shareholders. Reserving shares also provides a company's management team with a line of defense in the event another company is attempting a hostile takeover, in which case management can purchase additional shares to increase its equity ownership. In the event that all authorized stock has been issued into the equity markets, a company may bolster access to shares by issuing additional authorized stock, but only if the initiative is approved by its board of directors and common shareholders.
The percentage of shares owned by an investor becomes diluted when additional shares are issued in the market; the percentage of an equity holding decreases. As a result, the more authorized stock that a company has access to, the more a holding can be diluted, which can be damaging in the short term. If an additional stock issuance is likely to lead to greater profitability in the long term, however, investors may support the initiative.