Disclaimer: This essay has been written by a law student and not by our expert law writers. View examples of our professional work here.

Any opinions, findings, conclusions, or recommendations expressed in this material are those of the authors and do not reflect the views of LawTeacher.net. You should not treat any information in this essay as being authoritative.

Shareholder Wealth Maximization

Info: 2208 words (9 pages) Essay
Published: 20th Sep 2021

Reference this

Jurisdiction / Tag(s): UK Law

In these days, choosing the corporate objective of a firm is extremely important and has a determinant meaning to the success or failure of a corporation in controlling the market. To gain it, shareholder value maximization and stakeholders’ interest satisfaction play a key role in creating profit for company. Which governance objective should a corporation follow, maximizing shareholder value or satisfying stakeholder’s interests or balancing the interests of shareholders and stakeholders? This is an inextricable problem for each corporation to pursue its own goal. It’s difficult for the company to bring forward a right choice.

To make this issue clear, it’s necessary for understanding some basic concepts about shareholder, stakeholder, what is shareholder value maximization? And what are stakeholders’ interests? Shareholder is defined as an individual or corporation that owns one or more shares of stock in a company. They are the owners of the company, have potential profit if the company does well or potential loss if the company does poorly. Therefore, it’s a priority for shareholder value maximization which is defined: “Maximizing shareholder wealth means maximizing the flow of dividends to shareholders through time” (Glen Arnod, 2008). Why does a corporation maximize shareholder value? Because shareholders are persons sacrificing the immediate consumption to put their capital also hand over their savings for managers by purchasing the shares of company with the promise of a flow of cash in the form of dividends in the long run and not necessarily payback in short time. Maximizing shareholder wealth is often a superior goal of the company, creating profit to increase the dividends paid out for each common stock. Shareholder wealth is expressed through the higher price of stock traded on the stock market. An another constituency of contributing to value for company is stakeholder, Freeman defines it: “Stakeholder is any group or an individual who can affect or is affected by the achievement of an organization’s purpose”(Freeman, 1984, p.53). Stakeholders here include customers, suppliers, employees, creditors, directors, communities, environment, government officials… The different stakeholder groups have different interests. For example, customer’s interest is high quality products with cheap price, creditor’s interest is low risk and high payment, the society’s interest is social welfare maximization, the charitable organizations’ interest is to help unhappy people with a part of maintained profit of the company. A corporation following the stakeholders’ interest goal indicates that the manager makes decision based on all interests of stakeholders.

So far, there have been various points of whether a business should prefer value maximization for shareholders or interests of stakeholders as a governance objective of the company. According to Milton Friedman: “In a free enterprise, private property system, a corporate executive is an employee of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of society…In so far as his actions in accord with his social responsibility, reduce return to stockholders, he is spending their money”(Milton Friedman, 1970). Shareholders are owners of the firm and deserve any surplus the firm creates. Shareholders spend money to employ the executives with the desire that they will bring much higher dividend in the long run, act based on the interests of shareholders for the only purpose to maximize shareholder wealth. Friedman supports completely for creating value of shareholders, directors have the proxy responsibility to maximize shareholder wealth, any actions besides shareholder’s benefit are violations of this duty. It’s also supported by his saying “There is one and only one social responsibility of business- to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, engages in open and free competition, without deception or fraud”(Milton Friedman, 1970). He stressed on pursuing the high returns for owners as a main objective of the company and leads the best allocation of investment capital for society because the scare resource is utilized best for producing the optimum mix of goods and services. The only one responsibility of directors is to create value for shareholders, advancing shareholders’ interests above all others. Is it an out-dated theory which considers the company as a thing to be owned, an entity separated to other constituencies? Does a company do well without care various constituencies? It’s like a “zero sum game”, it means gain achieved by winner is loss of loser, if adding gain and loss together, the result is zero. This theory also implies that there is no win-win situation, in a game there has to be winner and loser.

But whether shareholder value maximization is the only objective of the corporation in market economy in these days or not, another point answers this question: “NCR is a successful, growing company dedicated to achieving superior results by assuring that its actions are aligned with stakeholder expectations. Stakeholders are all constituencies with a stake in the fortunes of the company. NCR’s primary mission is to create value for our stakeholders.”(NCR 1990 Annual Report: 2). The fact proves that one company is still successful in pursuing stakeholders’ interest goal to maximize its value. It indicates that managers should make decisions based on the interests of stakeholders, especially in a competitive environment as nowadays, satisfying stakeholders’ interests is very important. Stakeholders are persons indirectly creating a considerable value for the firm. It requires the company suitable policies for stakeholders’ needs. One survey of directors proved that NCR is not alone in this view: “.. board of directors no longer believe that shareholders is the only constituent to whom they are responsible”. (Wang, Jia and Dewhirst, H. Dudley, 1992). Explicitly, shareholder value maximization is not the only goal of the company, a company can’t do well without caring the interests of customers, suppliers, employees, or government environment.. Stakeholders are constituencies who play an important role in the fortunes of the company. Their primary mission is to create value for stakeholders. But one problem arises for stakeholder theory expressed in Michael Jensen’s writings below, and the corporation should consider related factors carefully before making decision of their choice.

Michael Jensen says: “Stakeholder theory effectively leaves managers and directors unaccountable for their stewardship of the firm’s resources…plays into the hands of managers by allowing them to pursue their own interest at the expense of the firm’s financial claimants and society at large. It allows managers and directors to devote the firm’s resources to their own favorite causes- the environment, arts, cities, medical research-without being held accountable…it is not surprising that stakeholder theory receives substantial support from them” (Jensen, 2001). Jensen attacks the stakeholder approach. He points out a company which acts in the stakeholder’s interests tends to make the executives in the firm to earn profits for themselves. Because there is separation of the ownership and control between the owners and managers, which makes managers to pursue objectives attractive to them. With characteristic of management, directors have the tendency to be lack of diligence, taking advantage of their position to raise their perks or participate in poor, less risky projects.. So, it’s not surprising when directors support stakeholder theory. One difficulty for directors to define the main goal of the firm is to satisfy interests of all stakeholders. In a real life, no one can serve both masters.. stakeholder theory directs the corporate managers to serve many masters. It is not clear, personal and causes directors confused in making decision. Besides stakeholder theory’s disadvantage, Jensen still states that the company can’t maximize the shareholder wealth if it ignores the rest constituencies. No company can create great value for its shareholders without stable growth of revenue, which comes from the relationship with customers, suppliers, bankers or government and so on.

Over some arguments above, we can see different points on corporate governance. Should a company go into the direction of creating value for shareholders over stakeholder’s interests? In my opinion, pursuing only one objective: shareholder value maximization or stakeholders’ interests is not optimal approach. I agree with the view of Michael Jensen. Shareholder value maximization’s still prior than stakeholders’ interests with an effective and clear strategy. Cola-cola company is typical example for making much money by maintaining a powerful brand name and manufacturing an enjoyable beverage for consumers, a form of maximization of shareholder value based on its brand name and product. Moreover, maximizing shareholder value also needs satisfaction of stakeholder’s interests because stakeholders are people who contribute indirectly in creating the value for the firm. To me, customer satisfaction is very significant in the business perspective nowadays. Any strategy which increases the investment of the company’s resource to increase customer satisfaction is aimed to increase the shareholder’s value if the economic return overtime exceeds the company’s cost of capital. The manager can set the price of each product or service no higher than the perceived price of the customer(the ceiling price) and no lower than the cost of capital (floor price), concurrently give many promotion programs such as buy one give one, reducing the product price for the increase in customer satisfaction. Moreover, the price of the product is not only reasonable for customers, suppliers, but also to the market situation, and importantly securing the profit for company, guaranteeing for shareholder value. There is no conflict between maximizing shareholder value and customer satisfaction in this case. However, it’s sometimes difficult for directors to choose between short-term and long-term goals. Because if the manager wants high price for short-term goal to raise the year’s profit but in the long run, with competition, the customers will transfer to consume the products of other firms with cheaper price, the failure in customer satisfaction will reduce shareholder value aimed to the long-term goal. I think it’s good for managers to note short-term and long-term goals. Because the goal of shareholder wealth maximization is a long term goal achieved by many short-term decisions to maintain or exceed the expected value of shareholders. So managers with desire to maximize value for shareholder need to consider both short-term and long-term impact on their decisions so as to increase the market stock price.

One reality, many firms nowadays choose the direction of satisfying stakeholder’s interest. I can’t say “right” or “wrong” here, it’s up to the corporation’s specific objectives to different perspectives. But I think the purpose of stakeholders’ interests shouldn’t conflict with the shareholder value maximization. Because serving the interests of stakeholders can create profit for the firm, create value for shareholders. The main goal of the company is shareholder value maximization but not ignore the stakeholder’s interests. For example, to suppliers, the company can pay for them with the market price, make payment on time, has preferential policies for excellent suppliers, builds good relationship with suppliers to increase volumes purchased, to improve the product’s quality, coordinating delivery-production schedules to minimize costs, which helps to maximize shareholder wealth. To employees, shareholder value maximization requires the company to have good human resources management because the workforce is very significant in creating superior value for company, it’s a competitive advantage of the company. A company which treats employees badly as pay lower salary than the market’s one or has no well treatment policy such as: health insurance, social insurance… is unlikely to maximize value possible for shareholders. Coca-cola, Disney and General Electric have the best human resources management. Policies with investment on training courses for employees are encouraged, increasing the competitive advantage of the company over rivals. In the long run, it will create value for shareholders.

In conclusion, the governing objective of the company should be to maximize the value of the company for shareholders. However, to achieve this purpose, it also requires serving the economic interests of all stakeholders over time. Maximizing stakeholder’s interests also maximizes shareholder wealth.

Cite This Work

To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Related Services

View all

Related Content

Jurisdictions / Tags

Content relating to: "UK Law"

UK law covers the laws and legislation of England, Wales, Northern Ireland and Scotland. Essays, case summaries, problem questions and dissertations here are relevant to law students from the United Kingdom and Great Britain, as well as students wishing to learn more about the UK legal system from overseas.

Related Articles

DMCA / Removal Request

If you are the original writer of this essay and no longer wish to have your work published on LawTeacher.net then please: