What is Overcapitalization
Overcapitalization occurs when a company has issued more debt and equity than its assets are worth. The market value of the company is less than the total capitalized value of the company. An overcapitalized company might be paying more in interest and dividend payments than it has the ability to sustain long-term. The heavy debt burden and associated interest payments might be a strain on profits and reduce the amount of retained funds the company has to invest in research and development or other projects. To escape the situation, the company may need to reduce its debt load or buy back shares to reduce the company's dividend payments. Restructuring the company's capital is a solution to this problem.
BREAKING DOWN Overcapitalization
In the insurance market, overcapitalization takes on a different meaning. Overcapitalization occurs when the supply of policies exceeds demand for policies, creating a soft market and causing insurance premiums to decline until the market stabilizes. Policies purchased in times of low premium levels can reduce an insurance company's profitability.
The opposite of overcapitalization is undercapitalization, which occurs when a company has neither the cash flow nor the access to credit that it needs to finance its operations. The company may not be able to issue stock on the public markets because the company doesn't meet the requirements or the filing expenses are too high. Essentially, the company can't raise capital to fund itself, its daily operations or expansion projects. Undercapitalization most commonly occurs in companies with high start-up costs, too much debt and insufficient cash flow. Undercapitalization can ultimately lead to bankruptcy.