EFFECTS/EVILS OR DISADVANTAGES OF OVER-CAPITALISATION
The effects of over-capitalisation may be discussed under the following three heads:
Effects on the Company
Decrease in the Value of Shares and Goodwill
Due to decrease in the earning capacity of the company, investors lose their a large majority of confidence in the company. Consequently, the market value of its shares comes down and the company's financial stability is jeopardized. The company also suffers a set back to its goodwill. investors.
Difficulty in Obtaining Capital
Due to fall in dividends the investors lose their confidence in company. As a result of this, the company finds its very difficult to obtain the requisite capital for improvements and acquisition of new assets by issuing shares or debentures.
Difficulty in Obtaining Loans
The credit standing and goodwill of an over-capitalised company also suffers a set back due to fall in earnings. Consequently, different financial institutions hesitate in providing loans to such a company for its development and expansion programmes.
Manipulation of Accounts
With a view to cover up the deficiency of the decreased earnings and to present a respectable figure of profits an over-capitalised company resorts to objectionable practices including manipulation of accounts. In this exercise, the company may not make adequate provisions for depreciation, maintenance, renewal and replacement of assets. It may even declare and pay unearned dividends from capital to revive its decreasing credit standing. Besides misleading the investors, this practice further aggravates the decreasing value of the company.
Demand for Liquidation
An over-capitalised company is not able to pay the principal amount of loan and interest thereon. In such circumstances, the creditors may forcefully demand liquidation of the to correct the situation. One company, unless drastic steps are taken effective remedy is reorganisation of the company's share capital, which would again lead to considerable loss of its goodwill.
Lack of Competitive Strength
An over-capitalised company generally lose its market to competitors because of its failure to produce goods at competitive cost as a result of inadequate provision for depreciation, repairs, maintenance, replacement of assets. Moreover, such a company is also unable to provide as much facilities to their customers as its competitors are providing. Consequently, it fails to retain its customers and lose the market.
Effects on Shareholders
Low Rate of Dividend
The shareholders of an over-capitalized company suffer a revenue loss on account of low return on their investment in the form of dividends due to low earnings of the company.
Low Market Value of Shares
The shareholders also suffer a capital loss on account of low market value of shares. The shareholders have to sell their shares below par, and suffer a capital loss through depreciation of their investments.
Small Value of Shares as Collateral Securities
The share ofover-capitalised company are not easily marketable due low earnings and lower dividends of company. Consequently, the share of such company have a small value as collateral securities. Commercial banks and other financial institutions are not willing to sanction loans against such securities. Even if they agree to grant loans against such shares, they insist upon strict terms and conditions which are hardly acceptable to an ordinary borrower.
Encouragement to Speculative Gambling
The low-priced shares of an over-capitalised company are invariably subject to speculative gambling. Thus, instability in prices of such shares encourages speculation, and the real investors have to suffer on account of this manipulation as well.
Effects on Society
Low Quality Products at Higher Prices
An over-capitalised company invariably does everything to increase its earnings. In this process, it reduces the quality and increases the price of products. Thus, the ultimate consumers stand to suffer in terms of both quality and price as they have to pay high prices for poor quality products.
Reduction in Wage and Labour Welfare Activities
An over-capitalised company, in its attempt to raise profits, also tries to cut the wages and welfare facilities of the workers which leads to soreness in industrial relations. The interests of the workers suffer not only because of substantial cuts in wages and other benefits but also because an over-capitalised company often resorts to retrenchment of the workers on grounds of low earnings in the company.
Fear of Unemployment
Due to reduced efficiency, an over-capitalized company finds it difficult to survive in the competitive market and is often forced to close down. The closure of a few over-capitalised companies tends to create panic in general. The industrial activity receives a set back; the consumers are deprived of goods and services; the creditors lose their credits; the workers lose their jobs, and the society a confronted with a depressing effect in general.
Under-utilization and Wastage of National Resources
An over-capitalised company is unable to effectively utilise the society's resources. Contrary of this, over capitalisation implies the wastage of national resources which otherwise could be used most effectively by those efficient companies who are in need of funds.
Encouragement to Speculation
The shares of an over-capitalised company are invariably subject to speculative gambling which is socially undesirable.
Dissatisfaction among Investors
Over-capitalisation implies reduced investors efficiency and possibility of failure of the business. The investor are, therefore, not willing to invest in such a company. Consequently, the industrial and economic development of the country is adversely affected.
