Question

1. Briefly explain ‘maximizing shareholders’ wealth’ and how this can be achieved in a case of public listed firms.

Answer 1

Traditionally, the aim of organizations was to maximize profit .This view has certain limitations.

For example, this does not take into account long term view of the organizations. Managers can make short term profit at the cost of long term health of the business.

Accounting profits can be made without adequate cash flow to the organization.

Maximizing shareholders’ wealth avoids the pitfalls of profit maximization.

Maximizing shareholders wealth considers future interest of the business and also cash flows to the business.

Maximizing shareholders wealth can be achieved by maximizing the share price. Share price of a publicly listed company represents present value of future cash flows.

Hence maximizing shareholders wealth ensures future cash flows (not profits)

Shareholders wealth can be maximized by:

• Proper capital structure decision to maximize Earning per share and minimize cost of capital
• Proper dividend decisions
• Maximize Free Cash Flows
• Ensuring adequate growth of earning
• Following Corporate Governance norms and social responsibility. These have impact on Market price of share.

All the above steps will increase market price and consequently the shareholders wealth.

Maximizing shareholders’ wealth is a holistic goal of an organization which gives direction to all other subordinate goals related to Marketing, Human Relations, Finance, Production ,Social Responsibilities.Shareholders Service etc