13.3 UNDER-CAPITALISATION
13.3.1 Meaning and Causes of Under-capitalisation
Under-capitalisation is the exact opposite of over-capitalisation, meaning that the value of assets is small in relation to the firm’s earnings. Naturally, the real value of the firm’s shares is higher than their book value and the market price of shares is higher than their par value.
Under-capitalisation generally occurs in a firm which is incorporated during a depression. This is because assets are acquired at lower prices, but during the following boom, the earnings increase. The result is that the rate of return increases rapidly. The other reason for such firms becoming under-capitalised is that during a depression earnings are lower, but when a recovery sets in, ...
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