When the average person considers a business firm, the concept of “shareholder wealth maximization,” in some form or other, will often be his immediate and obvious thought. Profits, high returns and optimistic corporate yearly reports is what differentiates a successful business from a failing one. This is the common understanding of business and its service to shareholders.
The Concept of Wealth
The concept of “shareholder wealth,” to put it simply, is really about both capital gains and dividends. Regardless of what model the firm uses — and many firms do not pay dividends — shareholder wealth is the normal operation of the firm and, importantly, shareholders’ main expectation. There are other corporate goals such as the maximization of sales, market share or the reduction of debt. These might not immediately lead to the maximization of wealth. The idea of shareholder wealth is tightly tied to the idea of continued business expansion and profits.
The Power of Wealth
Economists such as Bartley Madden and James Owens consider the maximization of shareholder wealth to be the natural outcome of profitable business practices. These, in turn, are also the same, or similar, to capital expansion. These two writers differ on this as the goal of all business, but the general idea is that such expansion is what makes shareholders happy. This leads to loyal shareholders, committed board members and the continual increase in share value. The media attention that such performance can generate can assist the public reputation of any firm.
Other than maintaining happy shareholders and gaining a powerful reputation, maximizing shareholder value has many advantages. It is almost too obvious that constant profits, reinvestment and expansion makes everyone happy. Managers see salaries and reputations increase, salesmen see high commissions, governments see more tax funds and more people are being hired to staff the expanding firm. While the disadvantages of this policy are not negligible, the vivid impression these advantages make on investors cannot be ignored.
The Significance of Wealth
Madden holds that maximizing shareholder wealth is not just the obvious purpose of the firm, but is also a requirement for the maximizing of social utility. If a firm is continually growing, investing and expanding, everyone benefits. Other corporate strategies, such as increasing market share, can lead to declining profits, which, in turn, can lead to higher interest rates on loans for any future investment. If a corporation takes profit and expansion as its sole purpose and goal, then all problems of the firm are smoothed out. In other words, questions of the long or short term, market share or even social responsibility are eliminated as the firm continues to expand. It is not about corporate “profits” in isolation, but rather the “wealth” of shareholders, which includes long-term planning, capital expansion and continual investment in equipment, land and buildings.