Concept Of Maximising Shareholder Wealth Example For Free

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Maximizing share holder wealth is a concept in which optimally increasing the long-term value of the firm is emphasized.

Milton Friedman recipient of the Nobel Memorial Prize in Economic Sciences is often quoted as saying “The business of business is business” He actually did say “”there is one and only one social responsibility of business-to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Friedman used the term profits, rather than “shareholder wealth” but the two are often seen as interchangeable. Not only is this not true, there is an increasing body of opinion that views the prime motive of “maximizing shareholder wealth” as deeply flawed. In the history accounting and finance, it is assumed that the objective of the business is to maximize the value of a company.

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Put simply, this means that the managers of a business should create as much wealth as possible for the shareholders. Given this objective, any financing or investment decision that is expected to improve the value of the shareholder’s stake in the business is acceptable. In short, the objective for managers running a business should be profit maximization both in the short and long-term. Shareholders are deemed as the owners of the business. Their main aim is to increase their wealth, finance managers are employed to achieve this aim. In order to maximise shareholder wealth it would mean “Maximising the flow of dividends to shareholders through time there is a long term prospective” (Arnold, 2005) Shareholder wealth is a short-term gain, and can be artificially increased without adding any tangible assets or products to the company’s rooster. You can, for example, simply lay off an entire short-term unessential department; say Research and Development – rather than the shop floor, and the next quarters profits will be increased. But what about the social responsibility of the workers made redundant in order to make share price healthy? That is the fallacy with an unthinking mantra of maximizing. Almost any executive decision, no matter how socially irresponsible or unethical can be justified as intended to increase the stock price. Managers on short term leash might stay at the same point on the demand curve but economize more on resource if they must maximize shareholder wealth. Economizing inputs tend to offset the maximiser’s reducing output. In an economy with widespread monopoly some firms encouraged to maximize shareholder wealth would primarily encourage while others should slash production and reduce allocative efficiency one cannot predict which effect would dominate. Traditional theory suggests that the key aim of any business is to generate the greatest possible value for the company,

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