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Financial Management

Wealth Maximization
Wealth maximization is a modern approach to financial management. Maximization of
profit used to be the main aim of a business and financial management till the concept
of wealth maximization came into being. It is a superior goal compared to profit
maximization as it takes broader arena into consideration. Wealth or Value of a
business is defined as the market price of the capital invested by shareholders.

Shareholder wealth is represented by the market price of a firm’s common stock

and maximizing it, is known as the major objective of a firm.

The reason why maximizing shareholders’ wealth should be the better goal is that
management should seek to maximize the present value of the expected future returns
to the owners (that is, shareholders) of the firm.

that a business concern should only consider the decisions that maximize the market
value of the share or the shareholders' wealth

The market value of share is treated as an indicator of efficiency and effectiveness of

the firm. When the firm maximizes the shareholders' wealth, the individual shareholder
can use this wealth to maximize his individual utility. It means that by maximizing
shareholders' wealth the firm is consistently operating towards maximizing
shareholders' utility.

When business managers try to maximize the wealth of their firm, they are actually
trying to increase the company's stock price. As the stock price increases, the value of
the firm increases, as well as the shareholders' wealth

It simply means maximization of shareholder’s wealth. It is a combination of two words

viz. wealth and maximization. A wealth of a shareholder maximizes when the net worth
of a company maximizes. To be even more meticulous, a shareholder holds share in
the company/business and his wealth will improve if the share price in the market
increases which in turn is a function of net worth. This is because wealth maximization
is also known as net worth maximization.
 Firstly, the wealth maximization is based on cash flows and not on profits.

 profit maximization presents a shorter term view as compared to wealth maximization.

Short-term profit maximization can be achieved by the managers at the cost of long-
term sustainability of the business.

Thirdly, wealth maximization considers the time value of money. It is important as we

all know that a dollar today and a dollar one-year latter do not have the same value. In
wealth maximization, the future cash flows are discounted at an appropriate discounted
rate to represent their present value.

 Fourthly, the wealth-maximization criterion considers the risk and uncertainty

factor while considering the discounting rate. The discounting rate reflects both time and
risk. Higher the uncertainty, the discounting rate is higher and vice-versa.

hareholder is defined as an individual or corporation 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”

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

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. 

ecause 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

o 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.

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.

If the company’s board of directors wanted the management to maximize

shareholder wealth, then the CEO’s compensation should be set based on the
growth rate of the Net Income of the company because the CEO can influence the
shareholder’s wealth only upto the level of operations or net income
The main financial objective of the management would be the maximizing the
shareholder’s wealth, so all the activities performed by CEO and its management
would be to increase the sales and net income. The operating income could be
raised either through the increase of gross profit or decrease in administrative
expense. So, management could increase the gross profit by increasing the sales or
increase the net income through decrease in the expenses.

he performance should be measured through (i) percentage increase in Sales, (ii)

percentage decrease of expenses, or (iii) overall percentage increase in net profit of the
company.

It would always better to measure the performance of the management through the growth
rate in reported profits instead of stock’s intrinsic value because management can only
influence the activities upto the operational level and hardly have any control in the financial
expenses or matters. The past activities or shares market value should not be allowed to
intervene the performance of the management in the current year because it is a part of
intrinsic value calculation.

There's not a single correct formula for this, but generally, you want to align
incentives/rewards with results. That's a universal truism for all employees in fact.

If a CEO is seen as having a possible material impact on how the company is valued,
then load them up with stock and options that are worth less if the share price drops
and explode in value if all equity holders enjoy a windfall as well. Give sales people
bonuses for hitting sales AND gross margin targets. Want to see how fast
profitability can go away? Link commissions to gross sales and give pricing authority
to the sales force. Lol.

For good people, you'll have to pay fairly / handsomely as a base since deferred
rewards such as via options vesting over three years doesn't pay the bills - and
there's only so much one person really can be held accountable for overall anyho

he board of directors should set CEO compensation dependent on how well the firm
performs. The compensation package should be sufficient to attract and retain the
CEO but not go beyond what is needed. Compensation should be structured so that
the CEO is rewarded on the basis of the stock’s performance over the long run, not
the stock’s price on an option exercise date. This means that options (or direct stock
awards) should be phased in over a number of years so the CEO will have an
incentive to keep the stock price high over time. If the intrinsic value could be
measured in an objective and verifiable manner, then performance pay could be
based on changes in intrinsic value. However, it is easier to measure the growth rate
in reported profits than the intrinsic value, although reported profits can be
manipulated through aggressive accounting procedures and intrinsic value cannot
be manipulated. Since intrinsic value is not observable, compensation must be based
on the stock’s market price—b ut the price used should be an average over time
rather than on a specific date.

Shareholders are the owners of the Company and the Board of Directors are the working body having
specialized individuals with expertise in various fields. The Board of Directors of the Company
should decide the compensation of CEO on the basis of the working of the Firm under his proper
guidance. The CEO compensation should be planned in such a way that the CEO should only be
rewarded on the basis of performance of the stocks of the Firm. The compensation package should
not be determined on the basis of the price of the Firm’s stocks. Consequently, the Options (or stock
rewards) should be segmented in over a number of years, it will act as an incentive for the CEO to
maintain the stock price always higher over time. The method of determining the intrinsic value of a
stock is very difficult and not always correctly measured. In view of the same, if stock’s intrinsic
value could be ascertainable, then...

Compensation should be structured so that the CEO is rewarded on the basis

of the stock's performance over the long-run, not the stock's price on an
option (expiration date) of the stock. This means that the options (direct stock
awards) should be phased in over a number of years so that the CEO will
have an incentive to keep the stock price high over time. It is easier to
measure the growth rate in reported profits than the intrinsic value even
though reported profits can be manipulated through aggressive accounting
procedures and that intrinsic values cannot be manipulated. Since intrinsic
value is not observable, compensation must be based on a stock's market
price - but the price used should be an average over time rather than on a
specific date.
Every public company has a goal of maximizing shareholder value. If they
didn't, they likely would not be in business for a long period of time. Many
of the massive accounting frauds that we have heard about over the years
have started because management gets nervous about shareholder value.
Management sees that the return is less than expected, and begins
thinking of ways to raise shareholder value. Unfortunately for companies,
particularly companies that are doing poorly, the numbers are the
numbers. There is no ethical way to raise shareholder value, or maximize
the ...

An argument can be made either way.

At one extreme
, we could argue that in a
market economy, all of these things are priced. This implies an optimal level of
ethical and/
or illegal behavior and the framework of stock valuation explicitly
includes these.
At the other extreme
, we could argue that these are non
-
economic
phenomena and are best handled through the political process. The following is a
classic (and highly releva
nt) thought question that illustrates this debate: “A firm has
estimated that the cost of improving the safety of one of its products is $30 million.
However, the firm believes that improving the safety of the product will only save
$20 million in product
liability claims. What should the firm do?”
Q1.11
International Firm Goal.
Would our goal of maximizing the value of the stock
be different if we were thinking about financial management in a foreign country?
Why or why not?
The goal will be the same,
but the best course of action toward that goal may require
adjustments due different social, political, and economic climates.
Q1.13
Agency Problems and Corporate Ownership
. Corporate ownership varies
around the world. Historically, individuals have own
ed the majority of shares in
public corporations in the United States. In Germany and Japan, however, banks,
other large financial institutions, and other companies own most of the stock in
public corporations. Do you think
agency problems
are likely to be
more or less
severe in Germany and Japan than in the United States? Why? In recent years, large
financial institutions such as mutual funds and pension funds have been becoming
the dominant owners of stock in the United States, and these institutions are
becoming more active in corporate affairs. What are the implications of this trend for
agency problems and corporate control?
We would expect agency problems to be less severe in other countries, primarily due to the
relatively small percentage of indivi
dual ownership. Fewer individual owners should reduce
the number of diverse opinions concerning corporate goals. The high percentage of
institutional ownership might lead to a higher degree of agreement between owners and

An argument can be made either way.

At one extreme
, we could argue that in a
market economy, all of these things are priced. This implies an optimal level of
ethical and/
or illegal behavior and the framework of stock valuation explicitly
includes these.
At the other extreme
, we could argue that these are non
-
economic
phenomena and are best handled through the political process. The following is a
classic (and highly releva
nt) thought question that illustrates this debate: “A firm has
estimated that the cost of improving the safety of one of its products is $30 million.
However, the firm believes that improving the safety of the product will only save
$20 million in product
liability claims. What should the firm do?

Yes, the goal of maximizing the value of stock could seriously undercut the
goals of avoiding unethical or illegal behavior because some managers will do
whatever it takes to generate profits, even if their actions are illegal. Yes, I
think that customer and employee safety, the environment, and the general
good of society fits into the framework of maximizing the value of stock over
all that’s good. For example, a manager of a pharmaceutical company may
not reveal that a certain type of medicine may increase the risks of cancer
because he/she wants to increase the sale of shares. In this case, the
concern for customer safety and the good of society has been completely
ignored.

I think being on the good side of these subjects is admirable but the bottom
line is that the goal of any company should be to maximize shareholder value
within legal limits. There is no duty to be ethical or moral. Many companies
spend alot of money trying to prove how they consider all of the stakeholders
and not just the shareholders but most would not do this unless it paid for
them to do so.

No, i really don't agree with the statement that "The goal of maximizing
shareholders' wealth conflict with other goals, such as product safety or
environmental protection". Playing with goals and product safety only can attract
short term increase in the wealth and in long term it will take even the principle
investment as well. Any fraud happened was because of deviation from product
safety to decrease the product cost to increase profit. But we all know the final
result, finish of product and even some cases whole firm.

We can take any example to support this. Lets take example of Apple, we all are
aware that iphones are costly as compare to other brands and they have only few
products (latest one) in their portfolio but still their shareholders wealth is increasing.
They are clear about their goal and product which attracts the customers. Customer
data protection, product safety features are the reason customers go for iphones.
Many competitiions came and gone but they still cash rich because of their goals,
product safety and environment protection. Customers sentiments are also attached
with environment and there is direct imapct on sales with environment protection
actions taken by the company..

So, I am not agree with the statement. To maximise the wealth one must comply the
environment protection regulations, product safety.