The effect of over capitalisation? The remedies to over capitalisation

The effect of over capitalisation on different selections of the society can be discussed under the following heads.

A. Effect on the corporation

(i) Destroys the goodwill: over capitalisation market by low earning capacity destroys the reputation of the company which ultimately effects the prospects of the business.

(ii) Difficulties in raising additional funds: Over capitalisation brings down the credit standing and the financial reputation of the company. Thus it funds difficulty in mobilising additional funds.

(iii) Borrowings at higher rate of interest: An over capitalised company which is not able to raise capital from the shareholders may get loans at higher rate of interest. It will further deteriorate the position of the company.

(iv) Resort to unfair practice:  It may force the management unhealthy practices of window dressing (fake report) of earnings that is may not provide sufficient depreciation and also neglect the maintenance and replacement of assets.

B. Effects on shareholders or investors :

(v) Low rate of dividend: The shareholders of an over capitalised company suffer a revenue loss due to low return on their investment in the form of dividend.

(vi) Low market value of shares: The shareholders suffer a capital loss on account of low market value of shares. They have to sell their shares below par value.

(vii) Loss of re- organisation or liquidation: If an over capitalised company goes for re- Organisation or liquidation, the shareholders are the worst sufferers. They are the last recipients of the residual amount of left after payment of others.

(viii) Encouragement to speculative gambling: The shares of an over capitalisation company are subjected to speculated gambling. The real investors have to suffer on account of this manipulation.

C. Effect on society: 

(ix) Low quality products at higher prices: An over capitalised company reduce the quality and increases the price of products. Thus, the consumer suffers in terms of both quality and price.

(x) Reduction in wages and welfare facilities: It attempts to raise profits by cutting the wages and welfare facilities of the workers. This may spoil the industrial relation.

(xi) Fear of unemployment: Over capitalised company is often force to close down. Their closure tends to create panic in general. The consumer are deprived of goods and services. The creditors loose their credit. The workers loose their jobs. Thus, there is a depressing effect in the society in general.

(xiii) Wastage of national resources: An over capitalised company is unable to utilize the society resources effectively. It implies the wastage of national resources.

(xiii) Fear of recession: Due to low purchasing power of consumers demand for goods come down. As the process continues recessionary conditions are witness gradually.

(xiv) Dissatisfaction among investors: The investors are not willing to invest in such a company. As a result, the industrial and economic development of the country is adversely affected.

  

Remedies to over capitalisation

In order to correct the situation caused by over capitalisation the following measures should be adopted:

1. Increase in earnings:  The earning capacity of the company should be raised by efficiency of human and non- human resources belonging the company. All types of waste full expenditures should be avoided.

2. Plough back of earning : Another remedy for over capitalisation lies in ploughing back of profits into the business for replacements and extensions.

3. Reduction of long term debts: It is desirable to convert over capitalisation by reducing long term debts. The debentures and bonds should be redeemed to restore parity between book value and it's real value.

4. Reduction of interest rate: The old debenture holders may agree to take new debentures of lower rate of interest when premium is given on new debentures.

5. Reduction of par value of shares: It is fine method to convert over capitalisation if the equity shareholders are ready to give their consent to it.

6. Redemption of preferred stocks: This can be tried in cases where the preferred stock is accumulative from the seller common stock at low prices.