when a company is overcapitalized its market value is less than its total capitalized value or its current value an overcapitalized company may end up paying more in interest and dividend payments than it can sustain in the long term being overcapitalized means that a company s capital management strategies are running inefficiently placing it in a poor financial position 
understanding overcapitalizationcapitalization is a term used in corporate finance to describe the total amount of debt and equity held by a company as such it defines the total amount of money that is invested in the company itself this includes both stocks and bonds companies can be either undercapitalized or overcapitalized here we focus on the latter but we go over what it means to be undercapitalized a little further down being overcapitalized means that a corporation s issued capital exceeds its operational needs the heavy debt burden and associated interest payments that an overcapitalized entity carries can be a strain on profits and reduce the amount of retained funds that the company has to invest in research and development r d or other projects raising capital may be difficult as a company s stock may lose value in the market as a whole being overcapitalized puts a strain on a company s earning potential there are several reasons why companies may find themselves in a position where they are overcapitalized some of the most common causes of overcapitalization include companies may also find themselves at risk of becoming overcapitalized when they either mismanage or underutilize the capital they have an overcapitalized company has several options available to correct the situation some of these options include if none of these options is viable then the company may want to seek out a merger or be acquired by another entity overcapitalization isn t just used in corporate finance it s also commonly used in the insurance industry when used in this context the supply of available policies exceeds consumer demand this situation creates a soft market and causes insurance premiums to decline until the market stabilizes policies purchased when premiums are low can reduce an insurance company s profitability special considerationsalthough it may seem detrimental to a business there is one advantage to being overcapitalized when a company finds itself in this situation it may have excess capital or cash on its balance sheet this cash can earn a nominal rate of return ror and increase the company s liquidity the excess capital also means that the company has a higher valuation and can claim a higher price in the event of an acquisition or merger additional capital can also be used to fund capital expenditures such as r d projects here s another way to look at overcapitalization when a company raises capital well above certain limits it may become overcapitalized again this isn t good for the company as its capitalized value is higher than its market worth overcapitalization vs undercapitalizationthe opposite of overcapitalization is undercapitalization just like overcapitalization being undercapitalized is not where any company wants to be undercapitalization occurs when a company has neither sufficient cash flow nor access to the credit it requires to finance its operations the company may not be able to issue stock on the public markets because the company does not meet the requirements or because the filing expenses are too high essentially the company cannot raise capital to fund itself its daily operations or any expansion projects undercapitalization most commonly occurs in companies with high startup costs too much debt and insufficient cash flow undercapitalization can ultimately lead to bankruptcy example of overcapitalizationhere s a hypothetical example of how overcapitalization works assume that construction firm company abc earns 200 000 and has a required rate of return of 20 the fairly capitalized capital is 1 000 000 or 200 000 20 instead of 1 000 000 company abc decides to use 1 200 000 as its capital the rate of earnings in this case becomes 17 or 200 000 1 200 000 100 due to overcapitalization the rate of return has dropped from 20 to 17 