Question

In 200 words or more,

What does it mean to say that managers should maximize shareholder wealth subject to ethical constraints?

What ethical considerations might enter into a decision that decreases cash flow or stock price?

Answer 1

The main objective of the shareholders is to maximize wealth of the shareholders. Maximization of wealth should be done subject to ethical constraints. For example, if the managers want to start a new project which might not be very favourable to the firm but due to the large size of the project, the manager wishes to pursue the project as it the manger compensation in linked with the size of projects the company undertakes. Undertaking this project does not passing the ethical test , these decisions does not lead to any wealth maximization within the firm so at the best these decisions must be avoided.

Every decision that a manager takes on the behalf of the firm needs to be properly evaluated , based on the future projections of cash flow, risk and timing. In evaluating these decisions no consideration has been given to the ethical aspect of a decision. In reality, in addition to the cash flow projections, every decision should be properly evaluated based on the ethical considerations. Ethical considerations are not cheating or deceiving the customers by providing them with true and accurate information of the product that they are willing to launch. Not exaggerating about the quality, price and durability. Transparent and true facts should be projected through the products , keeping up with ethics.These might not impress the investors as such and lower down the stock price due to uncertainty of the product success in the market on the minds of the investors. Not exaggerating the future cash flow projections in order to secure a loan at a lower rate of interest but projecting the true picture of finances.

These examples, might increase the risk of the project , increase uncertainty of cash flows and hence, lower down the stock price, even though the stock price could have been much higher if they has acted unethically.