1

Wealth Maximisation and Profit Maximisation in light of Corporate Finance

SUBMITTED TO
Dr. Y. Papa Rao
FACULTY MEMBER IN CORPORATE FINANCE

SUBMITTED BY
ONINDYA MITRA
B.A. LL.B (HONOURS) STUDENT
SEMESTER IX, SECTION – B, ROLL NO: 194

HIDAYATULLAH NATIONAL LAW UNIVERSITY

Uparwara Post, Abhanpur, New Raipur – 493661 (C.G.)

Date of submission: 23-10-19

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ACKNOWLEDGEMENTS

Thanks to the Almighty who gave me the strength to accomplish the project with sheer hard
work and honesty. This research venture has been made possible due to the generous co-
operation of various persons. To list them all is not practicable, even to repay them with words is
beyond the domain of my lexicon.

This project wouldn’t have been possible without the help of my teacher Dr.Y. Papa Rao, Faculty
Member, HNLU, Raipur, who had always been there at my side whenever I needed some help
regarding any information. He has been my mentor in the truest sense of the term. The
administration has also been kind enough to let me use their facilities for research work, I thank
them for this.

Onindya Mitra
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CONTENTS

Acknowledgements ...................................................................................................................... 2

Chapter 1: Introduction ................................................................................................................. 4

Research Objective ..........................................................................................................................7

Methodology ....................................................................................................................................7

Mode of Citation .......................................................................................................................... ..7

Chapter 2: Legal aspect of Wealth Maximisation……………….....................................................9

Chapter 3: Corporate Law and Profit Maximisation........................................................................12

Conclusions ................................................................................................................................... 16

Bibliography/ References............................................................................................................... 17
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CHAPTER 1: INTRODUCTION

Financial Management determines how funds are procured and used. They relate to a firm's
financing and investment policies. To make unavoidable and continuous financial decisions as
rationale, the firm must have an objective. The properly defined and understood objectives are
the key, to successfully moving from the firm's present position to a future desired position.
Since business firms are profit making organizations, their objectives are frequently expressed in
terms of money. Two primary objectives commonly encountered are maximization of profits and
maximization of wealth. The latter is an operationally valid criterion to be adopted to maximize
the welfare of owners.

Maximization of profits

Often, maximization of profits is regarded as the proper objective of the firms. However, this
concept is somewhat newer than the goal of maximizing the value of the firm. The term profit
maximization is deep-rooted in the economic theory. In simple terms, the rationale behind profit
maximization objectives is that it guides financial decision making. Profit is a test of economic
efficiency of the firm.

It provides the tool by which economic performance can be judged. Moreover it leads to efficient
allocation of resources as resources tend to be directed to uses which interims of profitability are
the most desirable. It also encourages social welfare. Financial management is concerned with
the sufficient use of an important economy resource i.e , capital. It is therefore said that
profitability serve as the criterion for the financial management decisions. The profit
maximization criterion suffers from three basic weaknesses.

i) Vague
Profit in the short run is quite different from profits in the long run. If a firm continues to operate
a piece of machinery without proper maintenance, it may be able to lower the operating
expenditure in that year leading to increase in profits. But the firm will pay for the short-run
saving, throwing the burden in future years, when the machine is no longer capable of operating
because of prior neglect. In other words, maximizing profits does not mean neglecting the long-
term picture in favour of short-term considerations.

ii) Ignoring the timing of returns

Profit maximisation strategy ignores the differences in the time pattern of the benefits received
from investment proposals or courses of action, because money received today has a higher
value than money received next year. A profit sealing organization, therefore, must, consider the
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timing of cash flows and profits. The reason for superiority of earlier benefits over future
benefits lies in the that that the former can be reinvested to earn a return. The profit
maximization criterion fails to consider the distinction between the returns received in different
time periods and, thus, treats all benefits equally valuable. But it is true that, benefits in early
years should be valued highly than benefits in later years.

iii) Ignores risk

Profit maximization does not consider risk. The shareholder of the firm may expect to receive
higher returns from investment of higher risk. This fails to consider that shareholders may wish
to receive a portion of the firm's return in the form of regular dividends.
In the absence of any preference for dividends, the firm can maximize profits from period to
period by reinvesting all earnings, using them to acquire new assets that will boost future profits.
But the non-payment of dividends usually leads to declaim in the market value of the firm's
share.

Wealth maximization

This is also known as value maximisation or net present worth maximisation. The wealth
maximisation criterion is based on the concept of cash flow generated by the decision rather than
accounting for profit which is basis of the measurement of benefits. Another feature is that it
considers both the quantity and quality dimensions of benefits. At the same time it also
incorporates time value of money".

The wealth maximisation objective as described by Ezra, Soloman is "the gross present worth of
a come of action is equal to the capitalised value of the flow of future expected benefit,
discounted (or capitalised) at a rate which reflects their certainty or uncertainty. Wealth or net
present worth is the difference between gross present worth and the amount of capital investment
required to achieve the benefits being discussed. Any financial action which creates wealth or
which has a net present worth above zero is a desirable one and should be undertaken. Any
financial action which does not meet this test should be rejected. If two or more desirable courses
of action are mutually exclusive (i.e. if only one can be undertaken), then the decision should be
to do that which creates most wealth or shows the great amount of net present worth1'. The focus
of financial management is, therefore to maximise wealth or net present worth.

The wealth maximisation objective is consistent with the objective of maximising the owner's
economic welfare. The wealth of the owners of a company - the shareholders - is reflected by the
market value of the company s shares.

Therefore, the wealth maximisation objective implies that toward objective of a firm should be to
maximise the market value of its shares. The value of the company's share is represented by their
market price, which in turn, is a reflection of the firm's financial decisions. The price serves as a
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performance index or report card of the fin's progress; it indicates how well management is
doing on behalf of its shareholders. Thus, the attention of financial management is on the value
to the owners or suppliers of equity capital. The wealth of owners is reflected in the market value
of shares. So, wealth maximization is a decision criterion.
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RESEARCH OBJECTIVE

The objectives of this research project are as follows:

1) To study the legal aspect of wealth maximization and profit maximization.

METHODOLOGY

This research project has been made following the descriptive-analytical approach. Reliance has
been placed on both primary and secondary sources of data. A number of case laws and
commentaries on Summons cases were relied upon for the purpose of making this project.

MODE OF CITATION

This research project has been made following the Bluebook Style of Citation (19th Ed.)

CHAPTER 2: Legal aspect of Wealth Maximisation

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SHAREHOLDER WEALTH MAXIMIZATION AS THE OBJECTIVE OF

CORPORATE LAW

Most recently, as society has come to absorb the corporate governance lessons learned from the
financial crisis of 2007–08, the shareholder wealth maximization norm has come under heavy
and fair criticism from leading corporate governance scholars such as Professors Lynn Stout1 and
Jay Lorsch.2 Moreover, there are alternative models of corporate governance that do not
incorporate shareholder wealth maximization as the objective. For example, Professors Margaret
Blair and Lynn Stout use their team-production approach to corporate governance to argue that
shareholder wealth maximization is not the correct objective of a public company.3

Nevertheless, in the world of corporate law, especially by those who take a law and economics
approach to corporate law, the objective of shareholder wealth maximization is firmly
entrenched.4 According to Professors Henry Hansmann and Reiner Kraakman, “There is no
longer any serious competitor to the view that corporate law should principally strive to increase
long-term shareholder value.” According to Judge Frank Easterbrook and Professor Daniel
Fischel, one can think of shareholder wealth maximization as the default rule under corporate
law because it is the “operational assumption of successful firms.”5 Much more recently,
Chancellor Leo E. Strine Jr. of the Delaware Chancery Court stated his own view in a Wake
Forest Law Review article that “the corporate law requires directors, as a matter of their duty of
loyalty, to pursue a good faith strategy to maximize profits for the stockholders,” 6 and that
directors should only receive the benefit of the business judgment rule if their decision was
motivated by a desire to enhance shareholder value. While not judicial precedent, Chancellor
Strine’s scholarly writings that promote the role of shareholder wealth maximization in corporate
law presumably have some influence on the legal thinking of judges and other Delaware
chancellors when they consider issues involving corporate decision-making. Shareholder wealth
maximization is also prominent in “theoretical” models of corporate law. For example, in a
1
E.g., LYNN STOUT, THE SHAREHOLDER VALUE MYTH:HOW PUTTING SHAREHOLDERS FIRST HARMS INVESTORS,
CORPORATIONS, AND THE PUBLIC (2012). Professor Stout has been arguing that shareholder wealth maximization
is not the appropriate corporate objective since at least 1999. See Margaret M. Blair & Lynn A. Stout, A Team
Production Theory of Corporate Law, 85 VA.L.REV. 247, 249 (1999) (“In this Article we take issue with . . . the
shareholder wealth maximization goal . . . .”).
2
Justin Fox & Jay W. Lorsch, What Good are Shareholders?, HARV.BUS.REV.,July–Aug. 2012, at 48.
3
Blair & Stout, supra note 26, at 249.
4
Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 GEO. L.J. 439, 439 (2001)
[hereinafter Hansmann & Kraakman, The End]; see also Henry Hansmann & Reinier Kraakman, Reflections on the
End of History for Corporate Law, in THE CONVERGENCE OF CORPORATE GOVERNANCE: PROMISE AND PROSPECTS
32 (Abdul A. Rasheed & Toru Yoshikawa eds., 2012) (suggesting that events over the last ten years have not
changed the relationship between shareholder wealth maximization and corporate law).
5
FRANK H. EASTERBROOK &DANIEL R.FISCHEL,THE ECONOMIC STRUCTURE OF CORPORATE LAW 36 (1991).
6
Leo E. Strine, Jr., Our Continuing Struggle with the Idea that For-Profit Corporations Seek Profit, 47 WAKE FOREST
L. REV. 135, 155 (2012) (emphasis added).
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principal–agent model of corporate law, shareholders are viewed as the owners of the
corporation and the board of directors and executive officers are their agents: Enterprises choose
the corporate form over other types of business organization to realize the gains produced by the
separation of ownership from control. This separation enables a specialization of function:
Shareholders supply capital and bear the risk that comes with their claim to the firm’s residual
product, and managers act as shareholders’ agents, using their expertise to deploy the principals’
capital in various ventures. . . . This “principal-agent” account of the public corporation, in turn,
implies a “shareholder primacy norm,” i.e., a recognition that directors and managers do and
should run the corporation so as to maximize the wealth of a single owner, namely, shareholders.
Shareholders employ directors and officers to run the company on their behalf and therefore
these agents’ goal should be shareholder wealth maximization. The results of corporate decisions
that do not focus on shareholder wealth maximization are referred to as agency costs. Hence,
corporate law should be structured to minimize such costs. 7 Alternatively, under a nexus of
contracts or “contractarian” model of the corporation, shareholders are not perceived to own the
corporation but are considered to be only one of many parties that contract with the corporation.
Nevertheless, the board of directors still has fiduciary duties to maximize shareholders wealth.
This is a result of the hypothetical bargain struck between shareholders and the other parties in
the corporation (or with the board of directors as in Professor Stephen M. Bainbridge’s director
primacy model of corporate law). In this hypothetical bargain, shareholders would argue that
since they are the least contractually protected versus other parties, they deserve shareholder
wealth maximization as the gap filler in their corporate contract.

In the models just described, a board of directors has a legal obligation to manage according to
shareholder interests.8 Such a legal obligation is enforced through the fiduciary duties of care and
loyalty that a board of directors and its executive management owes to their shareholders. Thus,
under these models, fiduciary duties are the tools of accountability with the objective of
shareholder wealth maximization. In addition, shareholders can effectively enforce these legal
obligations by filing direct and derivative lawsuits. Yet corporate law has shown very little
interest in directly enforcing the objective of shareholder wealth maximization. This lack of
interest is evidenced in all aspects of corporate law. First, Delaware General Corporation Law is
silent on shareholder wealth maximization. Second, court opinions rarely reference shareholder
wealth maximization as a guiding principle of corporate law and when they do it is mainly to
discuss the Revlon duty,9 i.e., the board’s duty “to seek the best available price . . . when a
company embarks on a transaction—on its own initiative or in response to an unsolicited offer—
that will result in a change of control.” 10 Third, in most cases the business judgment rule can
nullify the fiduciary duty of care. Likewise, in all duty of care cases where director liability is at
7
Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547,
547–48 (2003).
8
Hansmann & Kraakman, The End, supra note 30, at 440–41.
9
Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986) (establishing the Revlon duty
to maximize shareholder wealth when the break-up, sale, or merger of a company is inevitable).
10
Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 242 (Del. 2009).
 10

issue, an exculpation clause in a corporation’s certificate of incorporation can nullify the

fiduciary duty of care. Therefore, if in an overwhelming number of cases courts are not enforcing
the fiduciary duty of care, then how can it be said that this fiduciary duty is achieving the
objective of shareholder wealth maximization? Fourth, a judicial review for a breach of the
directors’ duty of loyalty is never triggered because a board decision has allegedly failed to
maximize shareholder wealth. A review for a breach of the duty of loyalty is only triggered when
a decision is either tainted or presumed tainted by a conflict of interest, a lack of independence,
or both. Corporate law makes the critical presumption that conflicts of interest or lack of
independence must lead to erroneous decision-making, and will find directors liable for the harm
caused by such decisions.11 This presumption is justified based on the logic that if a decision is
tainted with self-interest, then there is no basis for believing that the decision was made in the
best interests of the corporation or its shareholders. Thus, “there is no reason to preserve the
authority of the board.” When a board decision is so tainted, then a court will review it under a
fairness standard with the burden of proof shifted to the directors.

WHY COURTS AVOID THE REVIEW FOR SHAREHOLDER WEALTH

MAXIMIZATION

The focus on taint means that the courts are using the presence of agency costs as a filter for
determining whether to get involved in a review for shareholder wealth maximization. The courts
take this approach because they recognize that fiduciary duties—that is, as tools for achieving
the objective of shareholder wealth maximization—must take a back seat to the primary strategy
used by corporate law to achieve this objective: the protection and promotion of board authority,
or what can simply be referred to as “managerial discretion.” Preserving managerial discretion
necessarily means that fiduciary duties will be weak and that courts will primarily refrain from
determining whether a decision maximizes shareholder wealth. The problem is that this approach
is counterintuitive and therefore subject to being misunderstood, especially by those who have
been trained in the law and believe that accountability should always be the default rule.
Corporate law, however, takes a more pragmatic approach than the courts. It says that agency
costs are a part of corporate decision-making, and that these costs must be tolerated to a certain
degree to make sure that corporate decision-making comes as close to shareholder wealth
maximization as possible. This requires that the locus of authority for corporate decisions, and
therefore the determination of what is a shareholder wealth-maximizing decision, be vested in
the board of directors and not shareholders or the courts. To understand corporate law’s strategy,
it might be helpful to visualize a line with absolute managerial discretion at one end and absolute
accountability at the other, as represented by judicial review of every board decision for a breach
of fiduciary duties. On this line there is an optimal point between absolute authority and absolute
accountability that allows for shareholder wealth maximization. Corporate law, even though it

11
Michael P. Dooley, Two Models of Corporate Governance, 47 BUS. LAW. 461, 487 (1992).
 11

does not know exactly where this optimal point may lie at any point in time, has taken the
position that the optimal point must reside much closer to absolute authority than to absolute
accountability. In identifying where that balancing point may be, a court takes a very pragmatic
approach to how much accountability it should require in its review of corporate decisions. It
does so by trying to identify whether a board decision is tainted with interestedness, lack of
independence, or gross negligence. This approach provides accountability, but at the same time
defers the substantive component of corporate decision-making to the board of directors.

However, this is not necessarily the way it must always be. Corporate law may over time shift
the substantive component of corporate decision making away from the board of directors to
stockholders or the courts if it becomes clear that this will benefit the objective of shareholder
wealth maximization. As discussed below, there are several good arguments why the locus of
authority must remain with the board of directors for the foreseeable future to maximize
shareholder wealth. These arguments validate Professor Bainbridge’s argument that under
corporate law the “preservation of managerial discretion should always be the null hypothesis.”
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CHAPTER 3: Corporate law and profit maximization

The persistently ambiguous state of the law

In the corporate law academy today in the United States, the dominant view is that corporate law
requires managers to pursue a single aim: the maximization of stockholder profits. 12 One sign of
the dominance of the view is a certain triumphalism on the part of those who believe that
stockholder profit maximization is normatively desirable. For example, in a provocative article,
Henry Hansmann and Reinier Kraakman have announced “the end of history for corporate
law”:13 they argue that it is settled that the main purpose of corporate law is to maximize “long-
term shareholder value”, and they claim that legal systems in other nations are converging
towards this position, or will slowly but surely be drawn to it, in large part because of its inherent
superiority.14 Moreover, even some of those who support broader conceptions of corporate aims
concede defeat on the descriptive question whether corporate law requires an exclusive focus on
profit maximization. A recent example is Joel Bakan’s book, The Corporation, and the related
documentary film, in which corporations are “diagnosed” as psychopathic. Bakan argues that
corporations are that way because of corporate law, which he says obligates corporate managers
to exploit workers, communities and consumers if it will increase profits. In my view, both those
who praise an exclusive focus on shareholder profit maximization and those who deplore it
exaggerate its claim to describe accurately the state of corporate law in the United States. The
legal situation is, in fact, persistently ambiguous. In describing the duties of directors, U.S.
corporations statutes typically refer to “the interests of the corporation.” It is far from clear that
the plain meaning of these words requires that the interests of the corporation be understood as
synonymous with the maximization of the shareholders’ profits from the venture. Indeed nearly
half of the states have adopted so-called “constituency” statutes, which permit or require the
board of directors to consider the interests of non-shareholder constituencies in forming a
judgment as to the best interests of the corporation. Directors’ duties were originally articulated
by the courts as a matter of common law. The starting-point for any discussion of the case law is
the 1919 decision of the Michigan Supreme Court in Dodge v. Ford, in which the Court wrote: A
business corporation is organized and carried on primarily for the profit of the stockholders. The
powers of the directors are to be employed for that end. The discretion of directors is to be
exercised in the choice of means to attain that end, and does not extend to a change in the end

12
Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 VA. L. REV. 247, 303-05
(1999).
13
Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 GEO. L.J. 439, 439 (2001).
14
JOEL BAKAN, THE CORPORATION: THE PATHOLOGICAL PURSUIT OF PROFIT AND POWER 56-57 (Viking Canada
2004);
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itself. Although the case is often interpreted as announcing an uncompromising position on profit
maximization, subsequent case law has been more nuanced. Thus, for example, the Delaware
courts have held that corporate charitable contributions are permissible provided that they are
reasonable in amount and purpose.15 The reasoning of the leading judicial decision on this point
provides support both for the position that the law recognizes the intrinsic appropriateness of
corporate support for public causes, and for the seemingly contrary position that corporate
donations are legitimate only because they are ultimately beneficial to the shareholders. It is
commonly observed that, as a practical matter, courts will not interfere with corporate social
responsibility because there is almost always a plausible argument that actions considerate of a
corporation’s employees, customers or creditors or the environment are in the long-term interests
of the corporation’s stockholders. It has been easier, because of this fact, for courts to preserve
the ambiguity of the legal standard.
This is not to deny that there may be situations where the interests of shareholders and non
shareholders diverge in a manner that makes it more difficult to rationalize an act undertaken for
the benefit of a non-shareholder constituency as being also, ultimately, in the interests of the
shareholders. For instance, when a corporation is in financial distress, the stockholders’ interests
might well be served by the taking of severe risks that, if they pay off, will produce profits for
the corporation and its shareholders but, if they fail, will leave creditors unpaid. In such
circumstances, however, Delaware law does not require corporate management to prefer the
stockholders’ interests. To the contrary, the leading case holds that “a board of directors is not
merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise.” 16 The
other paradigmatic situation of conflict between shareholders and non-shareholders’ interests is
in connection with a hostile takeover, since the economic interest of the shareholders lies in
having access to an above-market bid for their shares even if the takeover is expected to be
detrimental to employees or another non-shareholder constituency. The Delaware courts have not
unequivocally held in this context, either, that management must prefer the interests of
shareholders. In the 1985 case of Unocal v. Mesa Petroleum, the Delaware Supreme Court held
that management may take into account the impact of the takeover on its non-shareholder
constituencies. In a series of cases over the following eight years,17 the Court qualified its
position by stating that consideration of non-stockholder interests was conditioned on the
presence of “rationally related benefits accruing to the stockholders” 18 and that a focus on
obtaining the best price for the stockholders must prevail over other considerations once the
directors have decided to abandon their “long-term strategy” or have decided to sell the
business.19 Significantly, however, the requirement to set aside a “long-term strategy”
reconciling the interests of non-shareholder constituencies and “benefits accruing to the
15
Theodora Holding Corp. v. Henderson, 257 A.2d 398, 405 (Del.Ch. 1969)
16
Credit Lyonnais Bank Nederland N.V. v. Pathé Communications Corp., No. 12150, 1991 Del. Ch. LEXIS 215, 108
(Dec. 30, 1991)
17

18
Revlon v. MacAndrews, 506 A.2d at 193.
19
Paramount v. QVC, 637 A.2d at 43.
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stockholders” does not arise unless management has already decided to pursue a sale of the
business or a change of control.20 That threshold decision, of course, may be made in the usual
manner and with due regard to non-shareholder interests. In light of this case law, one can easily
understand why the respected former chief justice of Delaware’s specialist corporate law court
has described the legal conception of the corporation as “schizophrenic,” and predicted that it
would likely continue indefinitely to be so. It is, to say the least, an overstatement to claim that
corporate law makes the interests of the corporation synonymous with the maximization of the
shareholders’ profits.

Profit maximization and the stock market

If the law does not obligate management to focus exclusively on the maximization of the
stockholders’ profits, there is nonetheless a mechanism which ensures that management’s
conduct is at least somewhat responsive to shareholders’ wishes: the stock market. If a
corporation is managed in a way that is congenial to current and potential shareholders, the result
will be a higher stock price. If management departs from what shareholders want, the stock price
will suffer and management will be punished either through the operation of equity-based
compensation, or, in more extreme cases, because a depressed stock price makes the corporation
a takeover target. In this way, to a degree of approximation, it is the aggregated preferences of
stockholders that ultimately determine management’s freedom to act responsibly, just as the
aggregated preferences of consumers ultimately determine whether cosmetics are “cruelty-free”
and whether the tuna fishery is “dolphin-safe.” I want to be careful not to overstate the case for
market discipline of management. Takeovers are, of course, expensive. 21 As for equity-based
compensation, Bebchuk and Fried have suggested that it is often structured in ways that reduce
its sensitivity to the stock price and that its main appeal, for managers at least, may be that it is
less visible than compensation in cash.22 Still, to say that the mechanism works approximately is
not to say that it does not work at all. The basic point is that the stock market makes management
sensitive to the aggregate preferences of current and potential stockholders. To be sure, the
influence of the stock market over the conduct of corporate management is itself attributable to
provisions of corporate law.23 Of particular importance is the shareholder franchise, a necessary
condition for the functioning of the market for corporate control. Nonetheless, corporate law
does not impose upon management an exclusive profit-maximizing duty, but merely links
management’s fate to the stockholders’ pleasure. The aggregated choices of participants in the
20
See Arnold v. Society for Sav. Bancorp, Inc., 650 A.2d 1270, 1289 (Del. Supr. 1994).
21
John C. Coffee Jr., Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer's Role
in Corporate Governance, 84 COLUM. L. REV. 1145 (1984).
22
Lucian Arye Bebchuk, Jesse M. Fried & David I. Walker, Managerial Power and Rent Extraction in the Design of
Executive Compensation, 69 U. CHI. L. REV. 751 (2002).
23
Lawrence E. Mitchell makes this argument in his book, CORPORATE IRRESPONSIBILITY: AMERICA’S NEWEST
EXPORT (2001).
 15

stock market will determine the extent of management’s freedom to pursue goals apart from
profit-maximization. In other words, if the critics are right that management pursues stockholder
profits to the exclusion of all considerations of ethics, decency and social responsibility, it is not
so much because corporate law requires it as because it suits the stockholders.

Conclusion
 16

There is always a contradiction between Profit Maximization and Wealth Maximization. We

cannot say that which one is better, but we can discuss which is more important for a company.
Profit is the basic requirement of any entity. Otherwise, it will lose its capital and cannot be able
to survive in the long run. But, as we all know, the risk is always associated with profit or in the
simple language profit is directly proportional to risk and the higher the profit, the higher will be
the risk involved with it. So, for gaining the larger amount of profit a finance manager has to take
such decision which will give a boost to the profitability of the enterprise.

In the short run, the risk factor can be neglected, but in the long-term, the entity cannot ignore
the uncertainty. Shareholders are investing their money in the company with the hope of getting
good returns and if they see that nothing is done to increase their wealth. They will invest
somewhere else. If the finance manager takes reckless decisions regarding risky investments,
shareholders will lose their trust in that company and sell out the shares which will adversely
effect on the reputation of the company and ultimately the market value of the shares will fall.

Therefore, it can be said that for day to day decision making, Profit Maximization can be taken
into consideration as a sole parameter but when it comes to decisions which will directly affect
the interest of the shareholders, then Wealth Maximization should be exclusively considered.

References
 17

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