Goals of the firms:
I.
Profit Maximization
II. Maximization of the Shareholders Wealth
I. Profit Maximization:
Profit maximization stresses the efficient use of capital
resources, but it is not specific(or ignore) with respect to the
time frame over which the profits are to be measured.
In short- term executives may used different assets to sell-off
and turn the cash to increase liquidity on corporate balance
sheets and than could easily increase profits. But this short
run profit taking strategy is not in the best long-term objective
and interest of the owners of the public corporation.
In microeconomics, profit maximization functions largely as a
theoretical goal, with economist using different models, charts
and tables to prove the case that in free market economy
firms behave rationally if they increase or maximize profit
based on information.
In this world of economics two(2) distinctive elements of
business are ignored:
1. uncertainty
2. timing
In reality, different investment projects differ a great deal
with respect to risk characteristics, and to ignore these
differences in the practice of corporate financing can result in
poor management decisions.
In business life there is a very definite relationship between
risk and expected return - that is,
private investors demand a higher expected return for
taking on the investment projects additional risk.
To ignore this relationship leads to improper decision making
to allocate the capital which could lead to long-term conflict
between existing investors and management.
II. Maximization of Shareholders Wealth
means maximization of the market value of the existing
shareholders common stock price – because the effects of all
financial decisions are included.
I.
II.
Private Investors react to poor investment or
dividend decisions by selling stocks and causing the
total market value of the public shares to fall.
Investors can react to good decisions by pushing
up the price of stocks and create wealth for the
shareholder.
If the owners of the corporation are to base financial
decisions on a single goal, that goal must be precise, not
allow for misinterpretation, and deal with all the
complexities of the real business world, including but not
limited to:
1. legal issues
2. environmental standards
3. ethical and cultural considerations
4. international dimensions
5. labor demand and rights
6. tax
The market price of the public corporation reflects the
value of the public corporations seen by its owners
(investors = shareholders = equity holders) and takes into
account the complexity and complications of
the real-business risks.
The unifying objective in corporate finance is to
maximize the share value of the public firm.
Investment projects, financing structure and dividend
decisions must be directed by management toward share
value maximization objective.
The objective is narrowed from maximizing firm value to
maximizing stockholder value or stockholder wealth.
How do we measure stockholder wealth?
1. In a publicly traded company, the stock price is an
observable and real measure of stockholder wealth
2. The objective of maximizing stockholder wealth can be
narrowed to maximizing stock price
3. The stock price possess unique value of measuring
stockholder wealth at any time, not limited to corporate
annual report or financial reports.
Why private investors focuses on Stock Price Maximization:
1. The stock prices are the most observable of all measures
that can be used to judge the performance of the publicly
traded corporation.
2. The stock price, in a market with rational investors,
reflects the long-term effects of the firm’s decisions
3. The stock price is a real measure of stockholders wealth,
since the stockholders can sell stock and receive the price
now.
Two mechanisms designed to provide power to stockholders:
I. The Annual Meeting, where the shareholders of publicly
traded firms are called to gather once every year at annual
meeting and decide directly on selection of the board of
directors
The shareholders who cannot attend the meeting can still
exercise their voting power by filling out a proxy.
A Proxy enables shareholders to vote in absentia for boards
of directors and resolution that will coming to a vote at the
shareholders meeting.
II.
The Boards of Directors is the body that oversees the
management of a public corporation.
The Board of Directors as elected representatives of the
shareholders, the directors are obligated to ensure that
managers are looking out for stockholders interests.
They have the power to change the top management of the
firm and have a substantial influence on how the
corporation is run and how the dividends are distributed.