Notes On Over-Capitalisation Vs Under-Capitalisation:

       There may be three stages of capitalisation- Over Capitalisation, Under Capitalisation, and fair Capitalisation. A concern should neither be over capitalized nor undercapitalized, it should rather aim to achieve fair capitalisation

       A company is said to be over-capitalized when its actual profits are not sufficient to pay interest and dividends at reasonable rates.

       Under capitalisation is just the opposite of over capitalisation. A company is said to be undercapitalized if its real value is higher than the book value of its assets.

       A comparative analysis can be done if the effects of both the conditions of capitalization are considered which are as follows:

Effects of Over Capitalization:

I Effects on the Company:

  1. It reduces the earning capacity of the company and decreases the confidence of the shareholders of the company which in turn reduces the goodwill of the company.
  2. It faces difficulty in acquiring capital due to low rate of interest existing in the market.
  3. An over capitalized company has low credit standing and goodwill in the market and as such the financial institutions hesitate to grant loan to such company.
  4. An over capitalized company has high risk of liquidation as it may not be able to pay the principle amount of loan and the interest thereon to the creditors.
  5. An over capitalized company cannot compete in the market because of its inability to produce goods at competitive costs.

II Effects on the Shareholders:

  1. The shareholders of an over capitalized company get low dividend on their investments.
  2. The shareholders also suffer a capital loss as because the market value of their shares falls and they have to sell their shares below par.
  3. Of an over capitalized company the value of the shares as collateral securities is very less as such the financial institutions do not sanction loan against such shares.
  4. The low priced shares of over-capitalized company often encourage speculative gambling.

III Effects on the Society:

  1. An over capitalized concern, to increase its profit; reduces the quality of its products and increases its price. Thus, it affects the consumers directly.
  2. To increase its profit, an over-capitalized company reduces the wages and salary of its workers. This lowers their standard of living.
  3. Overcapitalized concerns are often forced to close down creating wide spread unemployment.
  4. The industrial and economic development of the country is adversely affected because the investor does not invest funds in over concern.
Effects of Under-Capitalisation:

I Effects on the Company:

  1. Under-capitalization intensifies the degree of competition which may have a telling effect on the profit margin of the company.
  2. The tax liability of the under company tends to be narrow with an increase on the volume of profits.
  3. The marketability of shares of undercapitalized concern tends to be narrow because of exceptionally high market price of these shares.
  4. The share prices of undercapitalized companies register violent fluctuations and the speculators take undue advantages of the situations.
II Effects on the Shareholders:
  1. The shareholders get high dividend income regularly.
  2. Because of soaring high price, the shareholders may encash at any time.
  3. The shareholders can get loans on soft terms against the security of their shares because of high credit standing of the shares of the undercapitalized concern in the market.
III Effects on the Society:

       Under-capitalisation does not pose any economic problem on the society. On the contrary, it may prove to be a boon of the society.

  1. It encourages new entrepreneurs to set up new ventures and encourage the existing one to expand.
  2. It boosts industrial production.
  3. The consumers get variety of goods at relatively cheaper price.
Comparative Analysis Of Over-capitalization And Under-capitalization:

       Comparing the two, it can be concluded that over-capitalisation proves to be more dangerous to the company, shareholders, and the society as a whole.

       On the contrary, under-capitalisation may encourage competition but it may also stimulate dissatisfaction among the workers and the consumers.

       Form the above discussion, it can be concluded that neither of the two safeguards the interest of the company. Since both the situations are undesirable, it may be suggested that a company should neither be overcapitalized nor undercapitalized. It should rather aim for fair capitalisation.