Negative impacts of Over-capitalization

Over-capitalization has evil consequences from the point of view of the company, the society and the shareholders.

From the point of view of the company:

  • Over-capitalization will result in considerable reduction of the rate of dividend on the equity shares issued. This is because the profits which the company earns have to be distributed over an unnecessarily large number of shares.
  • With the disappearance of reduction of dividends, the market value of the shares falls, and the investors lose confidence in the company. The credit of the company suffers a setback. Should a company require more funds for the purposes of bringing about any improvement or acquiring new assets, it will find it extremely difficult to raise the necessary fund from the market.
  • Sometimes the company resorts to questionable practices including ‘window dressing’ in order to show a respectable figure of profits. Some people are downright dishonest and merely cook up an increase. Others avoid necessary expenditure so that the debit in the profit and loss account is reduced. In the latter case, the efficiency of the company will be still further undermined. For example, if maintenance of machinery and repairs to machinery are postponed, the damage to the machinery will be very heavy and the efficiency would be greatly reduced. This will further reduce profits.
  • It is often found that an over-capitalized company has to go into liquidation, unless drastic steps are taken to re-organize the share capital. Re-organization would again mean considerable loss of goodwill.

From the point of view of society

  • Over-capitalization is an indication of reduced efficiency. An over-capitalized concern is compelled to raise the prices of its products. With diminished efficiency it is usually not able to maintain the quality of its products. Thus, the public is a loser both as regards price an quality. An over-capitalized company may try to raise its profits by effecting cuts in wages of workers. This may affect industrial relations.
  • Since an over-capitalized concern is unable to compete with other concerns, it may have to close down. The closure of a few companies in this manner may well become the cause of general panic and alarm. This would affect the interests of the creditors. The workers would also lose their jobs.
  • Over-capitalization results in misapplication of society’s resources. The capital lying idle or being under-utilized by an over-capitalized concern can be better utilized by other concerns which are in need of funds.
  • The shares of an over-capitalized concern provide scope for gambling on the stock exchange. It is undesirable from the social point of view.

From the shareholders’ point of view

  • Over-capitalization means depreciation of investment. The shares of an over-capitalized company sell below par in the market. Originally the shareholders may have paid much more for them.
  • The shareholders have also to suffer due to a low return on their investment which, too, is not always certain and regular.
  • The shares of an over-capitalized company have relatively small value as security for loans which a shareholder may like to raise.
  • The low-priced shares of an over-capitalized concern are subject to speculative gambling. This harms the interests of the real investors.
  • When an over-capitalized concern tries to set its house in order through reorganization, the shareholders are the worst suffers. Re-organization would usually take the form of reduction of capital for writing off past losses. Such reeducation has to be borne by the shareholders. In the event of liquidation too, the shareholders have to content themselves with much less than their original investment.

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