Carl Icahn’s bid to force online auction giant eBay to spin-off its payment processing business, PayPal, and eBay’s resistance to the idea once again highlights the disconnect that often exists between company shareholders and management. It is widely accepted that companies should have only one goal, which is to maximize returns for investors. This works well for small and mid-size privately held businesses where senior managers often hold major ownership stakes and so the company’s interests are perfectly aligned with investor returns. It also works well for private equity sponsored deals where the investors play an ongoing and thoughtful role in the management of the company. For large enterprises, however, and particularly public companies, the reverse can be true. Contrary to popular belief, shareholders do not always hold a preferred claim to a company’s profits or assets. The rights of debt holders, employees, retirees, and even some large customers can supersede those of equity holders at different times and circumstances (such as bankruptcies). What this means is that CEOs tasked with running a company should focus as much on the preservation and growth of the business as on the maximization of shareholder wealth. In the free market system and in the long-term, the two will automatically coincide, even if in the short-term they diverge. Unfortunately, executives at major companies today are under pressure to maximize returns for investors every quarter, or for activist shareholders looking to cash in quickly on some perceived opportunity, which can lead to hasty business decisions, poor strategic planning, and acquisitions or divestitures that backfire later. More importantly, they are compensated based on short-term price performance rather than long-term business feasibility, which can misalign the interests of both management and current shareholders with the true welfare of the company. That is not to say that CEOs and Boards prioritize equity holders over other stakeholders and the best interests of the company in every case but the obsession with shareholder value can sometimes compromise a company’s innovation and strategic direction in favor of immediate profits. Recent examples of such myopic decisions include Blockbuster’s lost opportunity to transition to digital (thanks to Carl Icahn) and JCPenney’s failed makeover as a substitute for business strategy (thanks to Bill Ackman). Another point to remember is that shareholders in public companies do not assume the liability of true owners. The legal structure of public companies and business insurance policies shield equity holders from the bulk of corporate liability, including from indebtedness and legal problems. This weakens shareholders’ claims to pure ownership of the company – since assets and liabilities should theoretically be two sides of the same coin. Conversely, lenders arguably could lose a lot more from poor performance and employees often have their entire livelihood invested in a company and so those stakeholders have at least some claim to ‘ownership’ as well. Realistically, of course, we live in a capitalist society and our individual prosperity depends on it. Stakeholder capitalism, good as it sounds, is not necessarily the panacea for corporate woes nor any more fair than our existing system. The right and productive way to look at it is for companies to simply recognize the fact that nobody has a 100 percent entitlement to the rewards of a successful business, and to balance out the needs of different constituencies with the long term needs of the company itself. Financial prosperity in the long-term depends upon many things, including risk-taking and strategy, and not just on meeting quarterly earnings projections, and if management needs to make decisions that prioritize the former over the latter, that is simply good business practice. Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner, as well as at mutli-strategy hedge fund Ramius Cowen. He has appeared on CNBC’s Closing Bell, MSNBC’s The Cycle, TheStreet.com, and HuffPost Live on business topics. He is also the author of two thriller novels.
 You are free to use this image on your website, templates, etc., Please provide us with an attribution link Article Link to be HyperlinkedFor eg: Source: Wealth Maximization (wallstreetmojo.com) ExampleAdvantagesSome of the advantages are as follows: DisadvantagesSome of the disadvantages are as follows: ConclusionWealth maximization has both merits and demerits attached to it. It is a very important factor for every investor before one invests in a company. They bring about happiness by generating good returns to their shareholders, and they tend to invest more in such companies, which may be required for their expansion or growth. Frequently Asked Questions (FAQs)Why is shareholder wealth maximization the primary goal? To maximize shareholder wealth, a company’s main objective is to increase the price of its shares. Therefore, maximizing shareholder wealth might be beneficial since it offers managers of a company a specific goal for increasing value. Why are wealth maximization and profit-maximizing at odds with one another? Maximizing profits guarantees the company’s growth and longevity. Wealth maximization, in contrast, concentrates on a company’s long-term growth rate by growing its market share. What is the theory of shareholder value in wealth maximization? According to the shareholder theory, shareholders evaluate the worth of business assets using the two quantifiable indicators of dividends and share price. As a result, management should make choices that maximize the value of dividends and share price growth. Recommended ArticlesThis has been a guide to wealth maximization and its meaning. Here we discuss an example of wealth maximization along with advantages and disadvantages. You can learn more about from the following articles – It is time to take a hard look at the universally accepted principle that the goal of business is to maximise shareholder value. Although the concept seems entrenched in business practise, it actually originated in a 1976 article by two business school professors at the University of Rochester who postulated that corporate executives act as agents on behalf of the shareholders, who are in turn the corporation's principals. This raised the spectre of 'agency costs', which might be incurred if executives acted in their own interests rather than in the interests of their principals. The only safeguard against executives profiting at the expense of shareholders was to align both of their interests through a commitment to maximising shareholder value, and best incentivised by stock options for senior executives. This idea is so deeply ingrained that many people assume corporations are legally required to maximise shareholder value. But this erroneous assumption is thoroughly dispelled by Lynn Stout of Cornell Law School in a recent book, The Shareholder Value Myth and in a recent article in the Stanford Social Innovation Review by Antony Page and Robert Katz. These legal scholars persuasively debunk any such legal or fiduciary duty. Another excellent book, Fixing the Game, by Roger Martin, dean of the Rotman School of Management at the University of Toronto, goes further by pointing out that maximising shareholder value is actually a bad way to run a business. Martin explains the danger of managers who aim to optimise the price of the stock rather than the performance of the company with an analogy of football players betting on their own games. If the players focus on winning the game, all of their incentives align with excellent performance. However, if they are rewarded based on the betting pool, they begin to worry about managing the odds. Betting odds, like stocks, are based on expectations of future performance. The better a team does, the higher expectations run. Players who want to make money by betting must manage the bookies' expectations, either by strategically losing some games to lower expectations, or by taking greater and greater risks to achieve unprecedented levels of success. Either way, when players start playing to meet 'expectations' rather than to win the game itself, their team's performance suffers. The same insidious incentives arise when executives start managing to meet analysts' expectations rather than managing the business itself. Martin and Stout both compile evidence to suggest that the primacy of shareholder value has not actually benefitted shareholders but has instead turned into a bonanza for senior executives: in 1970, only 1% of a Fortune 500 chief executive's compensation was in stock options and the average salary of was $700,000 (£438,000). Today stock and stock options account for 80% of the vastly inflated average compensation, which has increased more than 1,800% to $12.9m (£8m). The ultimate irony may be that the allegiance to shareholder value has caused the very problem it was intended to cure: enriching senior executives at the shareholders' expense. Given long enough time on the horizon, the interests of the company, the investors, and the executives would ultimately align. But with an average chief executive tenure of four and a half years, and an average stock holding period of only four months, short-term pressures exacerbate the focus on manipulating the stock rather than building the business. The increase in high speed trading and the proliferation of hedge funds and private equity firms has further increased the short-term pressure for financial engineering rather than long-term value creation. The biggest cost of all, however, is neither to the company nor its shareholders, but to our society and our planet. The ubiquitous mandate to maximise short-term shareholder value has driven a deep wedge between business and society. The long term success of any company depends on the health and wellbeing of its employees, customers, and the communities in which it operates. Unfortunately, these factors do not affect the quarterly earnings that drive analysts' expectations. CEOs who manage the stock, rather than the company, have little reason to think about the social and environmental consequences of their actions. And the result – whether in oil spills or credit derivatives – brings devastation far beyond the company's own shareholders. But a small, yet growing cadre of sophisticated business leaders are beginning to expand their focus beyond merely maximising shareholder value to creating shared value. They are building strong companies and healthier societies at the same time; making money by reducing their environmental footprint, meeting the needs of low-income populations, and finding innovative, profitable solutions to social problems. One might expect that such an "altruistic" approach would diminish shareholder returns: instead, it keeps corporate leaders focused on the most powerful emerging trends and the long term fundamentals of their businesses. As investors like Generation Investment Management are increasingly discovering, maximising shared value is the best way to maximise shareholder value. Mark Kramer is founder and managing director at FSG and a senior fellow of the CSR Initiative, at Harvard Kennedy School of Government This content is brought to you by Guardian Professional. Become a GSB member to get more stories like this direct to your inbox |
What are some of the concerns about shareholder wealth maximization purpose of a businesses?
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