Polypropylene (PP) was reinforced with wood flour and impact modified with elastomers to increase stiffness and impact resistance simultaneously. Elastomer was added in 0, 5, 10 and 20 wt%, while wood content changed from 0 to 60 wt% in 10 wt% steps. Structure and adhesion were controlled by the addition of functionalized (maleated) polymers. Composites were homogenized in a twin-screw extruder and then injection molded to tensile bars. The results showed that composite structure is determined by the relative strength of adhesion and shear forces prevailing during processing. Structure can be controlled by the application of functional polymers within limits. Although embedding is favored by thermodynamics and further promoted by coupling, de-encapsulation occurs at the large shear stresses of injection molding even in the presence of a functionalized elastomer. Composite properties depend on composition, increasing elastomer content results in decreasing stiffness and strength. Model calculations showed that the elastomer does not contribute to load bearing, average stress in the matrix increases with increasing elastomer content. Local stresses and adhesion define the initiation of deformation processes around wood particles, which start at the same stress irrespectively of elastomer content. Local processes determine the mechanism of failure and composite strength independently of their mechanism.