The effect of under Capitalisation. The remedies for under Capitalisation.

Effect of under Capitalisation:-

     Under Capitalisation has both good and adverse effects on various interested groups in the company. They are analysed below:-

A. Advantages to the shareholders:-

(1) Higher dividend: Due to higher earning of the company the shareholders regularly receive higher dividends on their investments.

(2) Capital gain: The shareholders of under capitalised company also avail capital gains because the market value of share increase very rapidly.

(3) Easy loan: Since the shares of an under capitalised company have great value as collateral security, the shareholders can easily obtain loans against the security of such shares.

B. Advantages to society:- 

(1) General welfare: The entire society is benefited with higher earnings of an under capitalised company.

(2) Employee advantages: The employees get higher wages, boners and better amenities due to increased earnings.

(3) More production: Under Capitalisation encourages the establishment of new companies resulting in increased production. Thus it ensures regular supply of quality goods to the consumers at cheap prices.

(4) More employment: Establishment of new companies and expansion of existing ones creates more employment.

C. Disadvantage of under Capitalisation to company:

(1) Limited marketability of shares: As the existing shareholders donot want to dispose of such shares, the marketability of shares is considerably reduced.

(2) Severe competition: Higher earnings of under capitalised companies attract new competitors to enter the business and reduce its profitability.

(3) Industrial unrest: The employees begin to ask for higher wages, bonus and increased welfare facilities, etc. This leads to industrial unrest and affects the efficiency of the company.

(4) Opposition by consumers: Due to higher earnings, the consumers may feel that they are being cheated by over charging the prices for its product. This feeling may lead to consumer agitation for reduction in prices of products.

(5) Government interfarance: Under capitalised company attract the government interfarance to cut down the prices of its products to charge high profit taxes or to file a suit against such a company under anti trust laws of the country.

(6) Encouragement to speculation: High dividend rates on the shares of a under capitalised company leads to High market cotations. The management may manipulate share values and enter into speculations.

Remedies for under Capitalisation

The remedies for under Capitalisation are:-

(1) Splitting up of shares: The directors should split up the shares in order to decrease the rate of earnings per share. It doesn't affect the total Capitalisation because only the par value of stock is reduced.

(2) Increase in par value of shares: Under capitalisation may be remedied by increasing the par value of equity shares. This will lead to decrease in rate of earnings per share.

(3) Issue of bonus shares: The most widely used and effective remedy for under Capitalisation is the conversion of reserves into shares by issuing bonus shares. This will reduce both dividend per share (DPS) and overall rate of earnings.

(4) Issue of shares and debentures: Under capitalisation is due to inadequate capital, more shares and debentures be issued to the public.