Question

1) Describe shareholder wealth maximization. Why is it considered the main goal of a firm?

2) ) Classify the following two transactions into each of the five categories for financial markets:

a) An investor buys shares of a company's stock listed on the NYSE, from another investor.

b) U.S. Government sells new Treasury-bills.

Answer 1

You have asked two unrelated questions in the same post. I have therefore addressed the first one only. Please post the other question separately.

Part (1)

Shareholders own the company but they don’t manage it. They elect Board of Directors: Executive vs. non executive directors; independent directors. Board appoints top management and is supposed to ensure that managers act in the shareholders’ best interests.

Corporation is a permanent. Employees and managers are not. Even if managers quit or are dismissed and replaced, the corporation can survive. Existing shareholders can sell all their shares to new investors without disrupting the operations of the business.

Hence, the goal of an organization should be a permanent and long term and not transient or short term. It is therefore more important for a company to maximize shareholders wealth, rather than to maximize profits or have any other goals.

It should be considered the main goal of the organization because:

• Shareholders'wealth maximization is a modern, wider approach and it leads to sustainable growth
• Shareholders'wealth maximization leads to long term, deeper and superior performance over the life of the company
• This goal is cash flows driven and present value i.e. time value of cash flows is considered
• Shareholders'wealth maximization is sustainable, efficient goal of an organization
• Such a goal leads to creation of a sustainable organization with long term focus, profit maximization leads to a very narrow approach by managers that may compromise the sustainability for near term profits.
• Profit maximization may lead the managers to undertake frauds and manipulations.
• And last but not the least, wealth maximization in a way automatically leads to profit maximization. You can't create wealth unless you create sustainable profits. The other way round is not true. Profits may not necessarily create wealth or value for the shareholders.

Hence, shareholders'wealth maximization therefore is a superior goal than profit maximization: