Wealth maximization is a main goal of a business and financial management which used to maximize the profit of a company in a long-term. It is a superior goal when compared to profit maximization since it takes broader aspect into consideration. (Borad, 2017)
The value or wealth of a business will be defined as the market price of the amount of capital that invested by shareholders while shareholder wealth is represented by the market price of a firm’s common stock. Stock prices clearly show the timing and risk connected with profits that shareholders hope to get in future. It means the net worth of a company will increase when the wealth of shareholders increase. (Borad, 2017) The objective of shareholders wealth maximization is to aim for the highest market value of market shares in order to maximize the purchasing power of shareholders.
As wealth maximization is also known as net worth maximization, if a shareholder holds an increasing share in the company or business, his wealth will improve as well. It is a process that maximises the current net value of a business or capital gains of the shareholders with the objective of bringing the highest possible return of a company. The company who apply wealth maximisation of shareholders will take into consideration any risk factors that would compromise or outweigh the anticipated benefits in order to make sound financial investment decisions. (Business dictionary, 2017)
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(b) RATIONALE AND OPINION TOWARDS THE STATEMENT “MAXIMIZATION OF SHAREHOLDERS’ WEALTH IS AN ADEQUATE GOAL FOR FIRM”
In my opinion, I agree with the statement that “maximisation of shareholders’ wealth is an adequate goal for a firm”.
First and foremost, corporate can set maximisation of shareholders’ wealth as an adequate goal for a firm but should not over-focus on it. Like the article stated that “the Cult of Shareholder Value Wrecked American Business”, (Sjogren, 2016) the cult means a system of religious veneration and devotion directed towards a particular figure or object. When the corporate is focusing too much on maximisation of shareholders’ wealth, they will ignore other important factors. Hence, if the goal of maximisation of shareholders’ wealth being taken properly as a strategy it is able to give the company a lot more benefits.
For a business, the profit should not be the only objective, corporate should likewise concentrate on various other aspects like increasing sales, capturing more market share, return on capital, just to name a few, which will take care of profitability.
Since wealth maximization is long-term process, it refers the value of the company generally expressed in the value of the stock, while profit maximization is only for short-term process, which is mostly concerned about short-term benefits. (Peavler, 2017)
But then a short term horizon can only fulfil the objective of earning profit but may not help in creating wealth. It is because wealth creation needs a longer term, thus, financial management should emphasize more on wealth maximization rather than profit maximization as all decisions in value maximization was made to increase the total long-run market value of a firm. (Johnson, 2011)
So, maximisation of shareholders’ wealth is better as a goal of firm as profit maximization is a subset of wealth. To maximize shareholders wealth, the firm needs to maximize firm’s profit first. This might as well reach the effect of kill two birds with one stone since to reach the goal of maximisation of shareholders’ wealth, the firm will first increase the profit of the firm. Therefore, while achieving the maximisation of shareholders’ wealth goal, profit maximization being a subset will also be achieved, it will still facilitate wealth creation. (Johnson, 2011)
Besides, I have disagree that “to ‘maximize’ a company’s share price has no foundation in history or in law. Nor is there any evidence that it makes the economy or the society better off”. (Sjogren, 2016) Since the share price is a very directive and only way to look at the company whether it is doing good or bad. If the share price can’t even show a satisfied data, needless to say, the internal condition of the company’s operation. Thus, the share price of the stock measures the wealth of corporate, which in turn is based on the timing of returns or cash flows, their magnitude and risk. Maximizing share price means maximize company’s owner wealth and indirectly capable to give back to society by doing more social responsibilities. (Kokemuller, 2016)
To be more evidently, shareholders’ wealth maximization goal able to maximize the wealth the society through increasing their stock price. As the stock price increases, the value of the firm increases and the net worth of the individual who holds the stock wealth increases.
Though, in the article that given, Pearlstein points out that maximizing shareholder wealth promotes short-term thinking; stock is increasingly held for months, not years. (Sjogren, 2016) We need to know that there are hundreds or even thousands of peoples are buying the shares each and every day, so it is not necessary to worry about peoples will let go the shares if the company has providing a good return to them with the strategy of maximisation of shareholders’ wealth. Moreover, investors not only look at dollar profit but also profit margins, return on capital, and other indicators of efficiency, therefore to ensure peoples will hold the shares for a longer period, wealth maximization is a better option than profit maximization that does not achieve these objectives. (Peavler, 2017)
Last of all, the employees problems that arising from the “maximizing shareholders’ value” likewise keep pointing out in the article. To highlight the point, less and less of the wealth generated by the corporate sector was going to either frontline workers or top executives and almost all of that increase came from stock-based compensation. (Sjogren, 2016) It is not true for the company which maximizes shareholders’ wealth, when their executives start investing in new projects, it is able to maximize profits from existing products and services. The employees who work on it is also working on controlling the cost, adding value to the company through the process. These reflect in the price of the stock such as the increasing in Net Asset Value and Equity Per Share. (Amoah, 2017)
The increasing of stock price which done by the employees either frontline workers or top executives in those projects probably attracts more investors also to maximize the wealth of shareholders.
Corporate does put more efforts in managing their employees like giving them sufficient training and employees benefits to really reach the goal of maximization shareholders’ wealth but not to ignore other factors. Since employees represent the most significant resource that a company has. Productivity will declines if these employees are feeling unsatisfied or upset in any way. This may have negative effect on the company. Thus, management that being very much aware of this fact may consider motivate the employees to put up their best at the workplace, which will in turn help the organization to achieve other aims and objectives. (Amoah, 2017)
In a nutshell, maximizing shareholders’ wealth has long been a key goal for a business. All decisions that took by the company should align with the objective of making maximum profit and generating optimum growth in company share price with the maximization of shareholders’ wealth thinking. Regardless of some criticisms from environmental and social groups, maximizing shareholder wealth indeed provides some key benefits to a business. (Amoah, 2017)
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