Question

What are the challenges to shareholder value maximization

Answer 1

The question begs for ‘Challenges to shareholder value maximization’. For me there are two interpretations of this

1) What difficulties the company’s face in achieving its goal of shareholder value maximization

2) What are unanticipated risks faced by the company when its peruses the single objective of shareholder value maximization

I will comment on both.

1) What difficulties the company’s face in achieving its goal of shareholder value maximization

a) Principal Agent problem – Shareholders (principal) manage the company through professional management (agent). However, the management may take decisions which are in their interest but harmful for the company in the long term. Ex. An aggressive CEO looking for acquisitions which can harm the company in long term

b) Optimal Leverage – Cost of debt is less than cost of equity. So, companys may like to take debt instead of equity to maximise shareholder value. However, debt borrowing leads to bankruptcy risk

2) What are unanticipated risks faced by the company when its peruses the single objective of shareholder value maximization

      a)   Defrauding other stakeholders at cost of shareholders: Management might conspire with shareholders interested in short-term gains to extract value from the company at the expense of customers, employees, of the organization, the community in which the organization operated and ultimately society as a whole.

      b) Stock price manipulation – Management may time various actions for their personal benefit than that of shareholders as a whole

      c) Excess Greed – Possibility of excess greed in the executives can hamper the company in long term

      d) Outsourcing production to other countries etc which may have negative impact on the country

      e) Treating empolyees as disposable

      f) Resort to unethical practices such as corruption to stifle competition

      g) Concentration of economic power and risk of increasing income inequality