The Shareholder Wealth Maximization Finance Essay

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Date added: 17-06-26

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To understand and make it clearer, we should pay attention to several definitions of shareholder, stakeholder and theories of shareholder and stakeholder and what the differences between them are, and what debates between them? with the long-term ability of the corporation to remain a going concern. From the above views of the shareholder and stakeholder theory, I support the ideal "shareholder wealth maximization should be a superior objective over stakeholder interest" because as follows: As we know, from a modern financial perspective the main objective of a firm is to maximize its value to its shareholder. Value is represented by the market price of the company's common stock, which is a reflection of the 3 key variables: timing of cash flows, magnitude of cash flows and the risk of the cash flows that investors expect a firm to generate over time. Normally, profit maximization after tax (ETA) is regarded as the proper objective of the firm, but it is regarded as a goal of maximizing shareholder wealth because total profits are not as important as earnings per share (EPS). A firm could always raise total profits by issuing stock and using the proceeds to invest in Treasury bills for earnings. Even maximizing profit per share, but, is not a completely suitable goal, firstly because it does not show the time factor or period of expected interest. Secondly, next mistake of maximizing EPS is that it does not take interest in the risk or uncertainty of the future return flow. So, there are several investment projects will more risky than others. Consequently, the prospective flow of EPS would not be more ensured if these projects were undertaken. Besides, a firm will be more or less risky to be conditional on the amount of debt in relation to equity in its capital structure. This risk is considered as financial risk and it contributes to the uncertainty of the future flow of earnings per share too. For instance, there are two companies A and B with the same of the expected future EPS. However, the earnings flow of the company A depends significantly more uncertainty than the earnings flow of the company B, so the market price per share of the company A's stock may be lower. For the mentioned-above reasons, a maximization objective of EPS may not be the same as maximizing market price per share. The market price of a firm's stock represents the focal judgment of overall market participants as to what the value is of the particular firm. It mentions to present and prospective EPS, the timing, duration, and risk of these returns, and any other factors relating to market price of stock. The market price is regarded as a performance index of firm's progress and this let us know that how well management is running in behalf of its stockholders. In some circumstances the management goals perhaps differ from those of the firm stockholders. In a corporation (especially it goes public) whose stock is extensively held, stockholders give a bit of their control or influence over the company operations. When the company control is separated from its ownership, management may not completely try their best to do jobs for the best benefits of the stockholders. They perhaps feel satisfied to run and seek a growth level accepted and concerned a lot with maintaining their own existence than with firm's value maximization to its shareholders. The top important purpose to this management may be its own survival. Consequently, this leads to unwilling to face with reasonable risks for their fear of making a mistake, hence becoming easily seen to the suppliers of capital from outside. Then, these suppliers may give out a threat to management's existence. To exist over a long time, management has to know to behave by a way that is reasonably suitable with maximization of shareholder value. However, the objectives of the parties are not always necessary the same. Maximizing shareholder value, subsequently, is a consistent example for how a firm should act. When management does not follow these guides, we must recognize this as a restriction and make decision for the opportunity cost. This cost is measurable only if we decide what the result would have been had the firm attempted to maximize shareholder value. The purpose of capital markets is to effectively apportion savings in an economy from last savers to last users of funds who invest in real assets. If savings are interested in the top auspicious investment chances, a reasonable economic criteria must exist that manages their flows. In general, the savings allocation in an economy happens on the basis of expected return and risk. The market value of a firm's stock is both of these factors. Accordingly, it reflects the market's equilibration process between returns and risk. If making decisions in accordance with the likely effect upon the market value of its stock, a business will only be able to attract capital from outside when its investment chances defend the use of that capital in the whole economy. However, this is not to say that management should ignore the questions of social responsibility and stakeholders' interests. Namely, Social responsibility of a firm towards shareholders is to ensure good return on investment, towards employees is fair pay and working conditions, towards suppliers is prompt payment and fair procurement process, towards customers is fair price, safe product and after sales service and towards local community is providing jobs and supporting the community development activities, supporting education, and becoming actively involved in environmental issues like clean air and water. Hence, the stakeholders' interest is the interest of stakeholders said above. The stakeholder interests sometimes conflict or influence with the shareholder's interests in maximizing wealth. Furthermore, the criteria for social responsibility and stakeholder's interests are not clearly defined, making formulation of a consistent objective function difficult. Therefore, manager has to know to coordinate between the shareholder wealth maximization and its stakeholder interests with superior financial results. In conclusion, maximizing shareholder wealth is a superior objective which a business firm must obligatorily fulfill to survive. If firms do not operate with the goal of shareholder wealth maximization in mind, shareholders will have little incentive to accept the risk necessary for a business to thrive. However, this maximization of wealth is not understood to be at all costs. It will be a contented combination between shareholder and stakeholder interests with best financial results. Depending on each specific situation, each specific circumstance and each specific condition of firms, they can sort out what is the best solution for their organization.
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