EFFECTS, EVILS OR DISADVANTAGES OF UNDER-CAPITALISATION
Under-Capitalisation also has its own evil Like over-capilisation, Under-Capitalisation also has its own evil consequences which are-
Effects on the Company
Encouragement to Speculation
High dividend rate on the shares of an under-capitalised company leads to high market quotations of these shares. The management of such a company is inclined to manipulate share values and enter into speculation of these shares.
Limited Marketability of Shares
The marketability of an under-capitalised company's shares is considerably reduced, because the existing shareholders do not generally want to dispose off such shares.
Severe Competition
Higher earnings of the existing companies attract new under-capitalised competitors to enter the business. Consequently, cut-throat competition among rival companies tends to grip the business and reduce its profitability.
Industrial Unrest
Industrial relations in under-capitalised companies tend to be strained on account of the fact that employees begin to ask for higher wages, bonus, reduced working hours, increased welfare facilities, etc., out of the increased prosperity of the company in the form of higher earnings. This leads to industrial unrest, which adversely affects the efficiency of the corporation leading to decline in its profits.
Opposition by Consumers
In view of its high earnings, the consumers of an under-capitalised company may feel that they are being cheated by over-charging the prices for its products. Development of this feeling among the consumers may lead to consumer agitation reduction in prices of for a the products offered by an under-capitalised company. Consumers may also demand state intervention to control the prices of the products of such a company. Obviously, this would lead to reduce the profits of the company.
Government Interference
Under-capitalised company declare a high rate of dividend which attracts the government interference to bring down the prices of its products, Government may also resort to profit ceiling, or charge high profit taxes, or may file a suit against such, a company under anti-trust laws of the country.
Inadequacy of Capital
An under-capitalised company suffers from shortage of capital, and hence, it always depends on borrowed funds. Sometimes, it is compelled to borrow funds at a high rate of interest. This would lead to reduce its earnings and control by its creditors, who may also demand for its liquidation in case of non- payment of interest and the principal amount of loan.
Under-Capitalisation Leads to Over-Capitalisation
Due to huge retained earnings and long-term debt financing, the situation of under-capitalisation also leads a company to over-capitalisation in the long-run. Thus, an under-capitalised company is found to face the evil effects of over-capitalisation in the long-run, if suitable remedial measures are not taken to get rid of evil consequences of over capitalisation.
Effects on Shareholders
Under-capitalisation is always beneficial to the shareholders of the company.
- Due to higher earning of the existing company, the shareholders of an under-capitalised company regularly receive higher dividends on their investments.
- The shareholders of an under-capitalised company also avail capital gains, because the market value of the company's shares increase very rapidly.
- Since shares of an under-capitalised company have great value as collateral security, the shareholders are at an ease in obtaining loans against the security of shares under-capitalised company.
Effects on Society
- Under-capitalisation does not create any sort of economic problems for the society. In fact, the entire society is benefitted with the higher earnings of an under-capitalised company.
- The employees get higher wages, bonus, and better amenities.
- Under-capitalisation also encourages the establishment of new companies resulting in increased industrial production which ensures regular supply of quality goods to the consumers at cheap prices.
- Establishment of new companies and expansion of the established ones greatly assist in eradicating unemployment.
- When the employees and the consumers develop the feeling that they are being exploited by the company, they get dissatisfied and resort to agitations and industrial unrest.
