## Over-Capitalisation
### Definition
Over-capitalisation is a situation where a firm has more capital than it can profitably employ — assets are worth less than the issued share capital, and earnings are insufficient to pay reasonable dividends and interest.
> Think of it as: too much capital chasing too few profitable opportunities.
### Causes
| Cause | Explanation |
|---|---|
| Excess funds raised | Issuing more shares/debentures than needed for profitable use |
| Borrowing at high cost | Borrowing at rates higher than what the firm can earn |
| Overpaying for fictitious assets | Excessive goodwill or other intangibles that generate no returns |
| Poor depreciation policy | Under-provisioning for asset wear → assets overstated |
| Wrong earnings estimation | Overestimating future profits at the time of floatation |
### Consequences
1. Dividend and interest rates fall — earnings cannot support promised returns.
2. Share market price declines — reduced returns make shares less attractive.
3. Window dressing — management manipulates accounts to hide poor performance.
4. Reorganisation or liquidation — if severe, the company may collapse.
### Remedies
1. Reorganise the company — restructure the business to improve profitability.
2. Buy back shares — reduce capital base to match actual asset values.
3. Reduce claims of debenture-holders and creditors — negotiate lower obligations.
4. Reduce par value of shares — free up accounting capital to replace or write off assets.
### Key Test
A firm is over-capitalised if:
- Actual earnings < Expected earnings on the capital invested.
- Market value of shares < Book value consistently.