Abstract
Financial Management is concerned with the task of efficiently managing the resources of a company. This paper will attempt to discuss the relationship between shareholder wealth maximization and a firm’s profit maximization. Additionally, the paper shall also explore the commonalities as well as the distinctive features of both goals. Furthermore, the paper will contain an example showing that sometimes maximizing profits might not lead to maximizing shareholder wealth. Also, an article that is taken from a scholarly will be analyzed. Through the article, the goal of wealth maximization will be critically examined.
Relationship between the two Goals
In the short term, a positive relationship exists between shareholder wealth maximization and firm profit maximization. However, in the long term, the relationship varies depending on some factors. Both goals are governed by a firm’s internal policies, and both tend to maximize the firm’s earnings.
Similarities and Differences
The two goals share various similarities and differences. One similarity is that they both focus on current assets and aim to increase the business’s net worth. Another similarity is that both these goals aim to make the business sustainable in the long run.
There are several differences among the two goals as well. Nowadays, modern financial management concerns itself with ways through which it can maximize shareholder wealth maximization. On the other hand, traditional financial management was focused more on profit maximization. Another difference is that profit maximization focuses on short-term goals. On the other hand, wealth maximization focuses on long-term goals. Moreover, by focusing on wealth maximization companies will be able to evaluate businesses in real time. Furthermore, wealth maximization firms focus more on cash flows than profitability.
Example
In some instances, profit maximization might not lead to shareholder wealth maximization. For instance, a firm eliminates all research& development (R&D) expenses. While this would increase short-run earnings and dividends, long-run earnings would also be reduced. As a result, shareholder wealth would be reduced as well. The reason behind this is that the firm will be unable to produce new products and sell them without R&D.
Criticism Argument
The article discusses ethical considerations and shareholder wealth maximization (Poitras, 1994). The main criticism is that ethical issues are not taken into account in shareholder wealth maximization. To maximize wealth for the shareholders, management engages in unethical and socially reprehensible activities. For them, the only goal is to maximize shareholder wealth, and they will go to any lengths to ensure it.
The criticism is valid. In pursuing shareholder wealth maximization, the firm very often flouts rules and regulations without regard for others. It is a firm’s responsibility to ensure that its dealings are ethical. After reading the article, I find no fault with the criticism and consider it justified. I do not find myself questioning the goal of shareholder wealth maximization.
Conclusion
The two goals have a positive relationship in the short run. In the long run, the relationship depends on other factors as well. Despite the similarities, there are stark differences between the two goals. Shareholder wealth maximization is a modern approach compared to the traditional profit maximization approach. In some instances, profit maximization does not necessarily translate into wealth maximization. Moreover, in an attempt to maximize shareholder wealth, management flouts its social and legal responsibilities.
References
Laux, J. (2010). Topics In Finance Part I-Introduction And Stockholder Wealth Maximization. American Journal of Business Education (AJBE), 3(2). doi:10.19030/ajbe.v3i2.381
Poitras, G. (1994). Shareholder wealth maximization, business ethics, and social responsibility. Journal of Business Ethics, 13(2), 125-134. doi:10.1007/bf00881581
Shivdasani, A., & Zenner, M. (2004). 5. Best Practices in Corporate Governance: What, Two Decades of Research, Reveals /. U.S. Corporate Governance, 16(2-4), 29-41. doi:10.7312/chew14856-005
