Capitalization – Definition

Cite this article as:"Capitalization – Definition," in The Business Professor, updated March 8, 2019, last accessed May 31, 2020, https://thebusinessprofessor.com/lesson/capitalization-definition/.

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Capitalization Definition

Capitalization refers to the value of a company; it is the total amount of a company’s shares on the market or the total amount of assets that a company owns. Capitalization can also mean how interest is paid on loans.

A Little More on What is Capitalization

Capitalization is categorized into two depending on whether interest on loan is added to the initial capital or not. Granted, there are different formulas used to calculate capitalization. You need to understand these terms:

  •         Co- initial
  •         Cn – capital in year n
  •         i – Interest
  •         n – Number of years

In simple capitalization, the interest is dependent on initial capital:

Cn = Co = (1 + n (i))

In compound capitalization, interest earned is added each year to capital

Cn = Co (1 + i)

References on Capitalization

Academic Research on Capitalization

  • The capitalization, amortization, and value-relevance of R&D, Lev, B., & Sougiannis, T. (1996). Journal of accounting and economics, 21(1), 107-138. This paper looks at the effects of R&D capitalization on the decisions of investors and the finances of a firm. The research looks analyzes the value-relevance of R&D cap to address common concerns with its reliability and its objectivity. The research estimates the R&D of a sample of public companies and finds these estimates statistically reliable. The research further adjusted reported earnings for firms with R&D capitalization and concluded that these adjustments were value-relevant to investors.
  • Legal determinants of external finance, La Porta, R., LopezdeSilanes, F., Shleifer, A., & Vishny, R. W. (1997). The journal of finance, 52(3), 1131-1150. This paper samples 49 countries to show how legal regulations affect investors and capital markets. The paper analyzes investor protection, legal rules and the quality of law enforcement. The findings from this study are applied to both equity and debt markets. It showed that countries with weak investor protection, such as France, have less developed capital markets.
  • The cost of capital, corporation finance and the theory of investment, Modigliani, F., & Miller, M. H. (1958). The American economic review, 48(3), 261-297. This paper looks at the risks involved with the different methods that firms choose to finance daily and expansion. It further looks at the effects that capitalization decisions of a firm have on investor decisions.
  • Capitalization and the theory of local public finance, Yinger, J. (1982). Capitalization and the theory of local public finance. Journal of Political Economy, 90(5), 917-943. This paper argues that because the Tiebout literature does not account fully for local fiscal variable capitalization, the literature is not complete. The paper seeks to explain the need for capitalization and how capitalization affects the efficiency of local governments. The analysis focuses on Tiebout assumptions and combines housing bids with a median voter model.

Law, finance, and economic growth in China, Allen, F., Qian, J., & Qian, M. (2005). Journal of financial economics, 77(1), 57-116.  This paper analyzes why China with its undeveloped financial and law systems has managed to maintain fast economic growth. It found that the private sector contributes more to the economic growth of a country. It suggests that alternative financing channels and better governance are factors that support the growth of the financial sector.

The Capitalization of School Finance Reform, Gurwitz, A. S. (1980). journal of education finance, 5(3), 297-319.   This paper looks at the court rulings that increased funding in the poorer schools. While this has enhanced the quality of education in these schools, it has affected the distribution of finances to other sectors.

Do market capitalization and stocks traded converge? New global evidence, Narayan, P. K., Mishra, S., & Narayan, S. (2011). Journal of banking & finance, 35(10), 2771-2781. This paper looks at the convergence of stock markets based on 11 models on a sample on 120 countries. The study places countries into different panels including developing countries, CSI, OECD, low income, middle income and high income countries. The study also places countries into regional panels to include Arab States, Pacific, East Asia, South Asia, Caribbean, Latin America and Sub-Saharan Africa. It concluded that, the speed of convergence in most countries is between20 and 30 percent.

Corporate tax planning and thin-capitalization rules: evidence from a quasi-experiment, Overesch, M., & Wamser, G. (2010). Applied Economics, 42(5), 563-573. This paper looks at tax planning behavior by looking at inter-company finance and government countermeasures. This study uses a simple theoretical model that looks into the financial decisions of multinational companies to obtain empirical implications.

How loan portfolio diversification affects risk, efficiency and capitalization: A managerial behavior model for Austrian banks, Rossi, S. P., Schwaiger, M. S., & Winkler, G. (2009). Journal of Banking & Finance, 33(12), 2218-2226. This paper looks at how diversification of banks affects cost and profit efficiency, risk and bank capitalization. The study examines different managerial hypotheses and finds that although diversification has a negative effect on cost efficiency, it has a positive effect on cost efficiency and can reduce the realized risk of banks. In general, diversification affects the capitalization of a bank positively.

Stock markets, corporate finance, and economic growth: an overview, Demirgüç-Kunt, A., & Levine, R. (1996). The World Bank Economic Review, 10(2), 223-239. This paper analyzes the surging growth in stock market and how this is affecting world economics. It looks at emerging markets and how investors are reacting to these new markets.

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