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Financial Market — Business Studies STD 12 Commerce — Question

CBSE BoardEnglish MediumSTD 12 CommerceBusiness StudiesFinancial Market3 Marks
Question
Explain any three causes of over capitalization.
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Answer

Causes of over capitalization:
  1. Acquisition of Assets at Higher Prices: Assets might have been acquired at inflated prices or at a time when the prices were at their peak. In both the cases, the real value of the company would be below its book value and the earnings very low.
  2. Higher Promotional Expenses: The company might incur heavy preliminary expenses such as purchase of goodwill, patents, etc.; printing of prospectus, underwriting commission, brokerage, etc. These expenses are not productive but are shown as assets.
  3. Underutilization: The directors of the company may over-estimate the earnings of the company and raise capital accordingly. If the company is not in a position to invest these funds profitably, the company will have more capital than is required. Consequently, the rate of earnings per shares will be less.
  4. Liberal Dividend Policy: The company may follow a liberal dividend policy and may not retain sufficient funds for self-financing. This may lead to over-capitalisation in the long-run.
  5. Inefficient Management: Inefficient management and extravagant organisation may also lead to over-capitalisation of the company. The earnings of the company will be low.

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