Question

Discuss the topic of maximizing shareholder wealth. This topic has been researched and studied for many years, with mixed results. For example; Irving Fisher, a prominent American Economist, argued that maximizing shareholders wealth should be management’s primary goal (Cardao-Pito, 2016). Conversely, Sollars and Tuluca (2016) suggested that shareholders should only be rewarded with returns that are “commensurate with the risk they take”. (p. 203).

Briefly share your thoughts about shareholder wealth maximization. Then, explain the advantages and disadvantages of wealth maximization from the perspective of a company’s Chief Financial Officer. Include the effect on company stakeholders – internal (managers, employees) and external (suppliers, shareholders). Make sure that you include the effect on company stakeholders – internal (managers, employees) and external (suppliers, shareholders).

Answer 1

Maximizing shareholder wealth has long been a key goal for a typical for-profit business. The idea behind this approach is that all decisions and company activities should align with the objective of making maximum profit and generating optimum growth in company share price. Despite some criticisms from social and environmental groups, maximizing shareholder wealth provides some key benefits to a business.

The most overt advantage of a wealth maximization goal is that you make money for all owners of the business. Naturally, if you start a business on your own or with other investors, you'd like to make as much money as you can. If all of your business decisions connect with this end in mind, you could make enough money on the company's income or upon sale of the business to become wealthy.

Common Concerns

While these advantages of maximizing wealth are hard to argue against, you have to recognize potential drawbacks and criticisms. If you get overly wrapped up in the financial stakes of your decisions, it can take away from any intangible or altruistic goals you have, such as bettering your community. Additionally, executing decisions that only weigh bottom line results can attract criticisms from community activists that expect you to contribute to the community, or from environmental watch groups that expect you to operate with green-friendly policies.

Business ethics and social responsibility are closely related concepts that address how companies should conduct themselves. Business ethics is a general term that comprises an overall approach to moral and ethical decisions and activities. Social responsibility has evolved over time and essentially represents an expanded view of business ethics in the early 21st century. Operating ethically and responsibly can affect company relationships with key stakeholders for the long term

Stakeholder Groups

To understand the impact of stakeholders, you need to know who they are and how they relate to your business. Along with owners, customers, communities, employees, business partners and suppliers are key groups. Customers expect you to operate a business honestly and fairly while also offering a value-oriented solution. Communities expect companies to get involved and to give back. Employees expect a fair working environment. Business partners and suppliers expect you to manage your business relationships with high integrity and responsibility.

Advantages of shareholders wealth maximization

it is also important to realize that the goal of maximizing shareholder wealth has some advantages. Fistly, it explicitly considers the time value of money and risk factors of the benefits expected to receive to the owners. In other words, the elements of timing and risk must be considered by managers as they make an important financial decision, for example capital expenditures. Secondly, if a firm has a decision that can make the market price inceasing, it is a good decision. On in other hand, if it does not achieve the effective result, this should not be taken (at least not voluntarily). Finally, maximizing shareholder wealth is an impersonal aim. If stockholders oppose the company's policies, they can sell their shares freely and invest their fund in others, however, it is noticeable that the shares should be under more favorable terms than are available under any other stratergy. Also, investors will be possible to sell their shares with the best price if they have consumption pattern as well as risk preference which is not accommodated by the investment, financing and dividend decisions of that firm. They also can purchase shares in firms that closely meet the investor's needs.

For all above reasons, the shareholder wealth maximization is the superior objective in financial management. However, in term of theoretical reasons, many studies and financial books have proven that shareholder wealth rests on companies which are willing to build long-term relationships with stakeholders. So, focusing on the interests of stakeholders is the most important objective of the company to maximize shareholder wealth. Also, Michael C.Jensen stated that "A firm cannot maximize value if it ignores the interests of its stakeholders

Firstly, customers can be seen as the top of hierarchy of stakeholders. They are one of the most important factor and greatest challenge to primacy of shareholder interests. It is undebatable that "no company can create great wealth for its shareholders without a stable and growing revenue base, which can be only reached by having very satisfied and loyal customers" . So, a company wants to have an increasingly growing number of customers who are willing to pay money to have its products and services, it forces to meet the their satisfaction of product quality, reasonable prices, and good services. In other words, the product or service must be meet or exceeds expectations and is acquired at a price no higher than its perceived value.

Also, the grown in sales by creating value for customers will maximize the firm's stock price in the form of efficient and courteous service, adequate stocks of merchandise (Financial Management 12th, 2008, Eugene F.Brigham and Michael C.Ehrhardt, P.10). Therefore, the more volume of products distributed, the more shareholder value increased because of a vast profits after selling products and services.

Secondly, employees also are of vital important in stakeholder objectives of the shareholders. They are the primary workforce and the potential source of significant competitive advantage which can create the superior value directly. pursuing the objective of maximizing value for shareholders also maximizes the economic interests of all employees over time, even when maganement is forced to downsize the company". Thus, they will be faithful and devote all their skills and talent if company's management board appreciates their crucial role as well as give the best policies for employees including paying fair wages, maintaining fair hiring practices and safe working conditions, supporting education. In other word, "the keys to company success is that it must be the motivation for staffs to devote the cream of them".

Conversely, if the company does not give its mind to improving the employees' lives and spirits, they will not try their best to produce quality products, resulting in failure in satisfying customers. Consequently, the amount of cash flow is poor, therefore, poor stockholder returns is indisputable.

Furthermore, one factor which will generate unforeseeably great value of a firm is the interests of society as a whole. When businesses take a long-term view, the interests of the owners and society often coincide. Thus, it is absolutely indisputable that social responsibility with local communities and the environment in which the company operating are become an important consideration for the boards of companies, especially large companies, such as the source of supplies, for expamle rubber, wood, paper from managed forests as well as protecting the consumers and following the local business legislation. Therefore, the more a firm contributes social interests, the more value of trademark it generates.

Another important factor which affect directly to the company's business activity is suppliers. "Suppliers and supply chain management are both crucial to developing and implementing strategies that generate the hightest long-term cash flow" Marakon Associates, 1993. It is clearly acknowledged that suppliers will be stable and reliable partners if the managment board has a fair, reasonable treat to them. This is shown in implementing all provisions of contracts as well as pay the bills on time. Furthermore, if a firm depends mostly on imported materials, it is necessary for it to have a sustainable vendor in order to keep its operation stably.

Disadvantages of Maximizing Shareholder Value

Bad Business Practices

One potential drawback of the tendency of corporations to focus on maximizing shareholder value is that it can lead to poor or unsustainable business practices. For example, leading up to the global recession that began in the late 2000s, many financial institutions in the U.S. gave mortgages to borrowers who had poor credit in the hopes of making as much profit as possible. While such practices may have led to short-term gains, the resulting mass defaults and foreclosures eventually forced banks to absorb huge losses. In some cases, businesses partake in illegal or unethical activities, such as falsifying financial information, in order to boost shareholder value. Excessive focus on shareholder value is commonly cited as a factor that contributed to the recession that began in late 2007, which some have called the "Great Recession."

Forgetting About the Customer:

Corporations that concentrate on maximizing shareholder value might lose focus on what customers want, or might do things that are not optimal for consumers. For instance, a corporation might choose to cut production costs by using lower-quality parts in its products. While this might boost profits and the price of its stock, it is bad for consumers. Over time, this can tarnish the reputation of the company and its products, resulting in the opposite of the intended effect by lowering the value of its stock.

Employment and Outsourcing:

Another negative consequence of shareholder value maximization is that it can hurt employees. The lower a corporation's costs, the more profit it stands to make if its total revenue is constant, so corporations can benefit from cutting employee benefits and wages. If domestic labor is not cheap enough or not productive enough, businesses can outsource labor to foreign workers who are willing to work for lower wages.

Corporate Involvement in Politics

Government regulations and taxes can reduce shareholder value. As result, corporations often contribute money to help certain politicians or political parties, and lobby politicians in an effort to get the government to pass legislation that is favorable to them. Since corporations often have huge amounts of money at their disposal, they can be far more influential than any single voter. Politicians are sometimes criticized for acting in the best interests of corporations rather than in the best interests of citizens.

Conclusion

Though the primary objective is to incraese the sharholders wealth maximisation, however for any organisation there has to be balance betweeen welath maximisation and other goals like corporate social responsibility. This will enable the organisation to run buisness for longer period of time.