Problems With Profit Maximization Strategy Finance Essay

Problems With Profit maximization Strategy Finance Essay strivingholder Value is a monetary bourn which is the final measure to perk up whether the comp whatever is successful in enriching its plow divvy upproprietors or not. We stir tried to puzzle the difference between sh arholder and the avoucher richesiness and have reason out that declinationholder wealth is the supreme point of contention for whatever physical composition as in the retentive term it exit benefit some(prenominal) owner and sh areowner. Hence, both(prenominal) of them will be content. We first look at why stockholder note value maximization should be the primary final stage of any organization. Then, we look why at that place is dispute of the organization with the target of stockholder wealth maximization. Then, we looked at various agency problems that come repayable to this divergence. Then, we gave strategies on how managers poop affix shareholder wealth. At the destroy, we con cluded with the radical fantasy of s expungeholder wealth maximization and explained its utility.Who owns any organization which is listed in share market, obviously, the shareowners. These are those individuals who have bought stocks of the company which shows their ownership of the company. Even if business is a person satisfying, he is the shareholder. If the Business is uncollectible, the board of directors are make up of people who own the right by owning the majority of shares. Since, the shareholder own the company, they are entitled to maximum value generation from the m aney they have set uped (Ahlstrom 2010, pp 11-24).In old times, the traditional approach of companies was to increase the owners clams, scarcely there were multiple limitations worry-Any trusty has multiple targets opposite than increase shareholder wealth. These screw be manage achieving higher market share, great sales growth, more stable market position. The traditional approach didnt tu rn exclusively of these issues. shareowner wealth maximisation has multiple things to be looked into like Short term, Medium term and Long term stockholder wealthiness maximisationstockholder wealthiness Maximization everyplace a stopover of time.The traditional approach lost out to these points.Social Responsibility demand to become the most important aim of any organization. Big Organizations essential to give back society in perspective of the resources that they take from them. These big organizations need to devote something out of the do goods that they earn. The traditional approach didnt take in account this (Smith 2003, pp 52-76).Modern approach puts more emphasis on Shareholder riches Maximization sort of than owner profit maximization. This includes change magnitude the Earnings per share of all shareholder so that their net cost is maximised. Wealth increase is equal to what gross present worth in needed for raising profits in the future. This value take to be discounted as per the time frame to found out the annualized rate of fall out for the shareholder. In Shareholder Wealth Maximization, it places priority onward any other objective for the organization. Any action which has positive effective on Shareholder Wealth Maximization needs to be given over priority.In any capitalistic society, the ending of business should be Shareholder Wealth Maximization as mostly the ownership of goods and services is by individuals, since, they own all the means so that they mickle make money. Shareholder Wealth Maximization at the end leads to rise in value of the shares which at end maximizes wealth of the shareholder (Ahlstrom 2010, pp 11-24). .Maximizing Shareholder Wealth as the first GoalAny financial decision to become effective needs better understanding of organizational goals. Shareholder Wealth Maximization should deport the decision make of the firm which needs to be represented in the common stock price. Profit maximization shouldnt overshadow Shareholder Wealth Maximization as many a times decisions taken to maximize profits of the owner has a short term view and in the spacious term erodes the value of shareholder wealth. Warren Buffet, who has been the advocate of Shareholder wealth, says that long term economic goal of any organization should be increase the average annual gain of the intrinsic business value in their firm for their shareholders. Economic progress isnt shown by size of firm but by per share progress (Smith 2003, pp 52-76).Shareholder Wealth Maximization goal should be nigh wariness of firm seeking to increase the present value of their future of their shareholder but not increasing the profits of promoters. This return to shareholder needs to be given in the form of stop consonantic dividends as well as if any shareholder decided to sell of the stock. As long as the dividend stream or the value stream is flowing, it increases the value of shareholder. Also, the higher the jeo pardy for future wealth growth, it strike down the faith of shareholders on the company. Stock prices evermore show what is the clock and risk associated with the future benefits which hind end be reaped by the shareholders. Shareholder wealth is delimitate as per the total number of shares times the value of per share at which it trades in the stock exchange the company is listed (Van Beurden Gossling 2008, pp 407-424).The advantages of using Shareholder Wealth Maximization as an objective are-This considers the time period as well as the risk in investing in the firm. Managers must take in account this while making decisions like expenditure so that in contributed to increase shareholder wealth.Shareholder Wealth Maximization can be tested with every decision which is do by organization so that consistency in decisions can be maintained. If the decision increase shareholder wealth it is a good decision, other it isnt, hence it shouldnt be taken.Shareholder Wealth Maximizati on is impersonal by nature. Shareholder is free to take their funds out and sell the shares and invest anywhere. If the shareholders risk preference isnt according to the decisions make by the firm, the shareholder will sell the sticks owned by him and invest in the organization which has scoop profile as per his investment needs (Bejou 2011, pp 1-6).For all of these reasons, Shareholder Wealth Maximization should be the primary goal to be achieved by any firm. But, the issues like social responsibilities managerial objectives, agency problems can create loss from pure Shareholder Wealth Maximization behavior shown by managers as well as promoters and more considerate in profit maximization. Nonetheless, Shareholder Wealth Maximization objective gives a standard on which every managerial decision can be judged and screened on (Ahlstrom 2010, pp 11-24). .Divergent ObjectivesThe goal of shareholder wealth maximization is about how financial decisions should be made in an organizatio n. But, not all management decisions need to be made by this. Using the index of managerial setance, we can measure the managerial success in achieving the shareholder wealth maximization objective. They should try and feed to maximize Economic Value addition which is the difference between profit after tax and the cost of capital employed to generate that profit. double corporations like Coca Cola, AT T, and General Electric use this ideal of Economic Value added (Husted de Jesus Salazar 2006, pp 76-91).It has been seen that all those firms which dont give attention to stockholder sakes and are more indulged in promoter profit maximization perform poorly in long term. There is always a divergence in shareholder wealth maximization goal and the other objectives which are undertaken by management. The main reason for this divergence is shareholders are real owner but rule is with promoters in all corporations. This separation of ownership and control allows manager to pursue s elf-promoting goals which are not in line with shareholder wealth maximization. They are consistent to maintain the control of the company. Instead of pursue the goal of shareholder wealth maximization, managers just work for satisfying or look for acceptable levels of shareholder wealth increase, while working for their interest improvement (Shaw 2009, pp 565-576).The maximization of personal welfare of managers can lead to long run job security of themselves. The focus on long term survival of managers limits the risk taken by firm as discriminatory outcomes can lead to disastrous outcomes for the firm. Similarly, the need for job security is one reason why management doesnt allow any merger offers given by other companies. The Golden Parachute approach is usually in the interests of managers more than the shareholders wealth. Now days, multiple companies give top management stock options which ensures their ownership in the company. Pan-American gives retirement option in commo n stocks which ensures that they hypothesise on the options to increase the share price. This helps in alignment of interests of managers with those of shareholders (Bejou 2011, pp 1-6).Agency ProblemsThe battlefront of diametrical objectives of owners and managers is one kind of agency relationship problem. Agency relationships materialise when one individual hires other individual so that he can perform duties on behalf of his. They delegate the decision making to the agent. These kinds of agency relationships hold out between stockholders and managers and those of stockholders and creditors. When we talk about agency relationship between stockholders and managers, the inefficiency rises as each party works in a way to maximize its interests and utility. The management thinking for looking for long term survival rather than thinking about shareholder wealth maximization. other(a) example is about using company airplanes, limousines and offices without having any ownership in the firm. This shirking by managers is an issue. Enron Corp lost $1 billion of investments in 2001. In 1991, Enron permitted their chief financial officer to purchase assets and minimize the risk of Enron. The CFO made million personally. This dispute of interests made way for Enron filing for bankruptcy in Chapter 11 (Smith 2003, pp 52-76).In Enron Case, the agency issue was poorly handled which led to shareholders feel the brunt of this mismatch. Agency cost include1) Expenditures made for minimizing the incentives for management which management took for removing decisions in contrast of shareholder interest, Such as giving management compensation in from of stock option of the firm.2) Expenditure to oversee management action like audits both external and internal.3) Protection of organization from managerial dishonesty.4) Opportunity cost of lost chances collectible to complex structure of organization (Husted de Jesus Salazar 2006, pp 76-91).Managerial motif act in the stoc kholder interest when they have stock in form of compensation, the threat of losing their job and threat of being taken over by any other organization. Agency problems and related cost can be decreases if financial markets are efficient enough. Also, it can be make with the use of complex contracts in financial terms. Agency problems lead to costs which reduce the value of firm on market place (Bejou 2011, pp 1-6).The Other agency conflict is between shareholder and creditors starts from the relation between owners and creditors. Creditors always stake a fixed claim on companys resources in lieu of long term debts, bank loans, commercial agreements and other instruments. The returns given to creditors are fixed while those to shareholders are variable due to stock price. Owners can try to make risky investment decisions, but creditors need to be paid back in full but investments need to be made as early as possible. Creditors to protect their money wait for other protective covers from company line bond indentures, limitation on dividend payments, types of Investments Company can make, poison pills and new debt application. This all can reduce the potential market value of the firm (Ahlstrom 2010, pp 11-24).Problems with Profit Maximization schemeIf Managers of any firm want to work in the direction of shareholder wealth maximization, they should look beyond their conventional thinking of owner profit maximization. Profit maximization model isnt useful for decision making due to multiple reasons like 1) The standard macroeconomic model for any firm is static. Profit maximization argot compare short term and long term profits. Profit decisions should be reflected on time basis. And should have a long term impact on the firm2) Profit is find outd in accounting terms between costs and revenue, but it doesnt define any priority on multiple things like maximization of dictatorial profit, rate of profit as well as earnings per share.3) The tolerate problem is profit maximization of owners gives no way for managers to seek the risk assessment option. Tw projects giving same profits can have different risk profile (Cosans 2009, pp. 391-399)ConclusionThe complete concentration on shareholder wealth maximization has been under criticism since the dot com burst. A shareholder value increase talks about benefit of the owners only but doesnt talk about the social issues like employment, environment and ethics. Any management decision can maximize shareholder value but can lower welfare of other stakeholders listed above. A Company while making decisions for maximizing shareholder value can also prove hurtful to interests of its customers as multiple decision regarding product lines can have effect. Also, shareholder wealth maximization strategy needs to have a long term view not a short term one. The intrinsic value of any business is brought up by the combination of financial might, societal contribution, employee satisfaction and shareholde r interests maximization. This is said to be stakeholder value maximization. However, this concept is very hard to implement as every decision cant be useful to all stakeholder. They need to be prioritized and weighted upon before implementing nay managerial decision