## Under-Capitalisation
### Definition
Under-capitalisation is the reverse of over-capitalisation. It occurs when a firm's actual capitalisation is lower than its proper capitalisation as warranted by its earning capacity.
> The firm earns more than its capital base would suggest — it is actually more valuable than its books show.
### Typical Cause
Firms that have insufficient recorded capital but large secret reserves — for example, when:
- Asset values have appreciated significantly but are not revalued in books.
- The firm reinvested profits without increasing nominal capital.
### Consequences
1. Dividend rate is higher than similarly-placed companies (high earnings per share of nominal capital).
2. Market value of shares is higher than similar companies.
3. Real value > Book value — understatement of true worth.
### Effects on Stakeholders
| Stakeholder | Effect |
|---|---|
| Competitors | Attracted by high profitability → increased competition |
| Workers | Demand higher wages seeing high dividends |
| Public | Feel exploited by the 'hidden' profits |
| Management | May manipulate share values for personal gain |
| Government | May attract greater regulation and higher taxation |
### Remedies
| Remedy | Mechanism |
|---|---|
| Split shares | Divide each share into smaller denomination → dividend per share falls, EPS on new shares normalises |
| Issue Bonus Shares | Capitalise reserves → more shares issued free → earnings spread over more shares → dividend rate falls |
| Revise par value upward | Exchange existing shares for higher face value shares → aligns book value with real value |
> Important: Stock split keeps EPS unchanged (more shares, proportionally lower EPS per sub-share adds up to same total). Bonus shares reduce the EPS and dividend rate even though total earnings remain the same.