0115 966 7955 Today's Opening Times 10:00 - 20:00 (BST)

The Objective Of Shareholder Wealth Maximisation

Published: Last Edited:

Disclaimer: This essay has been submitted by a student. This is not an example of the work written by our professional essay writers. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

We all know that a firm has responsibilities for a number of interested parties or claimants like shareholders, creditors, customers, employees, managers, society, etc. Stakeholder theory states that "managers should make decisions so as to take account of the interests of all stakeholders in a firm" (Jensen, 2001). Stakeholders are various, ranging from financial claimholders to employees, managers, customers, suppliers, local communities, government, etc. They may have different or conflicting objectives. For example, customers want high-quality products and services with low prices; creditors expect low risk and high returns; and the society wants the firm's high social expenditures. Thus maximising multiple objectives is difficult to realise in practice, especially when conflicts exist among them. Meanwhile, shareholders are those provide funds to a business in expectation that they receive the maximum possible increase in wealth for the level of risk which they face (Arnold, 2008). In other words, we can say they are people who own stocks or shares in a company in hopes of making a profit. Maximisation of shareholder wealth is measured by the market price of the firm's stock which reflects three 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) that directly affect shareholder's wealth. "Maximising shareholder wealth means maximising the flow of dividends to shareholders through time - there is a long-term perspective" (Arnold, 2008). These mean that SWM focuses on the firm's owners and is a single objective. Therefore, financial experts consider SWM as a superior goal.

Freeman (1984) and others give no conceptual specification of how to make the trade-offs among stakeholders that must be made. This makes the stakeholder theory damaging to the firm and to the social welfare, and it also reveals one reason for its popularity (Jensen, 2001). The stakeholder theory gives no criteria for what is better for or what is worse, it leaves the board of directors and executives in firms with no principled criterion for choosing among alternative actions and constituencies. The theory provides no criteria for problem solving in firms, thus if the firm that try to do behave only by the dictates of stakeholder theory will eventually fail because natural selection will eliminate them if they are competing with firms that are behaving so as to maximise value (Jensen, 2001). According to Arnold (2008), both theoretical and empirical literature supports the assertion that manager should focus on SWM. The practical reason assumes that "the decision-making agents (managers) are acting in the best interests of shareholders then decisions on such matters as which investment projects to undertake, or which method of financing to use, can be made much more simply" (Arnold, 2008). This means that a single objective can help the firm's managers to make clearer decisions.

Theoretical literature also supports the assertion that managers should give the first priority to SWM. "The contractual theory views the firm as a network of contracts, actual and implicit, which specify the roles to be played by various participants in the organisation. For example, workers sign both an explicit (employment contract) and an implicit (show initiative, reliability, etc) deal with the firm to provide their services in return for salary and other benefits; and suppliers deliver necessary inputs in return for a known payment. Each party has well-defined rights and pay-offs. Most of the participants bargain for a limited risk and a fixed pay-offs" (Arnold, 2008). Meanwhile, shareholders are asked to pour money into the business at high risk. They are residual claimants and do not have prior explicit or implicit claims. Shareholders can add to their wealth only after satisfying all the prior claims of every other participant. They bear all the risk of failure and therefore it is only fair that they get the rewards. Therefore, SWM is good for not only the shareholders and but also the society because the shareholders' wealth comes from wealth created by the firm after fully compensating everyone involved and the society for all the resources used (V. Sivarama Krishnan, 2009).

Arnold (2008) also gives us another theoretical reason on practicalities of operating in a free market system. It is argued that a firm will find it hard to survive if it wants to reduce returns to shareholders and "direct more of its surplus to the workers" (Arnold, 2008). These actions will not encourage shareholders, then they will sell their shares and reinvest in other firms. As a result, "employees would find it relatively more difficult to change employers, customers could lose an essential source of supply, and certainly local communities are hurt if an organisation ceases to exist" (Edward Freeman, Jeffrey S.Harrison, Andrew C. Wicks, Bidhan L.Parmar and Simone De Colle 2010: Pg129). Therefore, shareholders should get the most importance in managerial decisions as they "are the only constituency of the corporation with a long-term interest in its survival" (Jensen, 1989).

"For over 200 years, it has been argued that society is best served by businesses focusing on returns to the owner" (Arnold, 2008). Jensen (2001) forcefully argues that maximising the market value of the firm provides the "most purposeful, single-valued objective function," which is necessary for efficient management of the firm. This paradigm assumes that there are no externalities and all the participants engaged in transactions with the firm are voluntary players competing in free, fair and competitive markets. Shareholder wealth maximisation is seen as the desirable goal not only from the shareholders' perspective, but also as for the society. Therefore, firm wealth maximisation would lead to the maximisation of society's wealth as well (V. Sivarama Krishnan, 2009). Jensen also warned against "allowing managers too much discretion with regard to allocating resources to satisfy a broad group of stakeholders. His admonition stems from a mistrust of managers and their propensity to allocate resources according to their own desires at the expense of efficiency" (Edward Freeman, Jeffrey S.Harrison, Andrew C. Wicks, Bidhan L.Parmar and Simone De Colle 2010).

Another persuasive reason for managers of the firm to pursue the goal of maximising shareholder wealth is that they are the owners of the firm. In an interview in 2003 Milton Friedman said "one final and powerful reason for advancing shareholders' interests above all others (subjects to the rules of the game) is very simple: they own the firm and therefore deserve any surplus it produces" (Arnold, 2008).

Although Jensen (2001) rejects most of the claims of the stakeholder theory on the grounds that the theory does not provide a clear organisational objective and does not specify how to make necessary tradeoff among the competing interests of the different stakeholders. He concedes that a firm cannot maximise value if it ignores interests of its stakeholders. Jensen proposes what he calls "enlightened value maximisation" or its identical twin, the enlightened stakeholder theory. Long term value maximisation is specified as firm's objective. This objective can, of course, be satisfied only with the cooperation and support of all relevant stakeholders (V. Sivarama Krishnan, 2009). In other words, we can say a corporation will face troublesome if it only cares about what to do to realise its prime objective of SWM without satisfying other stakeholders like customers, the government, the environment, etc. We can take Vedan, a Taiwanese-invested monosodium glutamate maker in Vietnam, as an example for this circumstance. In 2008, environmental police found that Vedan had directly discharged 105.6 million litres of untreated wastewater per month into the Thi Vai River in southern Vietnam for 14 years. The toxic water killed farmers' fish and shrimp and ruined farmland along the river's banks. The firm then was fined VND267.5 million and had to pay VND127 billion in overdue environmental fees (Vietnamnews, 2010). Seriously, a number of supermarkets, wholesalers and several other Vietnamese businesses decided to remove Vedan's products from their shelves to boycott the polluting firm (Saigon Times Daily, 2010), forcing Vedan to agree to pay VND45.7 billion, VND53.5 billion, and VND120 billion to farmers in HCM City, Ba Ria-Vung Tau and Dong Nai provinces, respectively (Vietnamnews, 2010).

From Vedan's case, we can see that a firm must focus on reconciling "shareholder wealth maximisation with stakeholder perspectives" (Edward Freeman, Jeffrey S.Harrison, Andrew C. Wicks, Bidhan L.Parmar and Simone De Colle 2010) in order to facilitate the firm's sustainable development. Good corporate governance will be a key tool to help the firm to harmonise the relations between the firms' owners and stakeholders. Arnold (2008) cited Milton Friedman as saying that "the best system of corporate governance is one that provides the best incentives to use capital efficiently" (Simon London, Financial Times Magazine, 7 June 2003, p.13). This means that corporate governance plays an important role in realising the firm's primacy objective of maximising shareholder value as it is the system of management and control of the corporation that comprises a range of legislation and rules and regulations to encourage directors to act in shareholders' interests.

From my observation, Vinamilk, one of Vietnam's leading dairy corporation and among the bluechips on Vietnam's main bourse of Hochiminh Stock Exchange (HOSE) with market capitalisation of VND30.182 trillion ($1.55 billion) as at December 12, 2010, is a typical example in Vietnam for operating with the primacy goal of SWM and also satisfy its other stakeholders like customers, suppliers, community, etc. Vinamilk (coded VNM) clearly states on its website at (vinamilk.com.vn) that "We aim to maximise shareholder value and pursue a business growth strategy based on the following principal components: Expansion of market share in existing and new markets; Develop a comprehensive portfolio of dairy products to target a broader consumer base and expand into higher margin value-added dairy products and Development of new product lines to satisfy different consumer preferences." Thanks to clear objective and good corporate governance, Vinamilk has maintained a stable and high dividend payment for its shareholders over the past years. The firm paid cash dividend payment of VND3,900/share in 2008. In 2009, it had a cash dividend payment of VND2,000/share and a stock dividend payment at ratio 1:1. In 2010, its cash dividend payment increased to VND5,000/share (www.cafe.vn). In addition, VNM's share price remains high at above VND80,000/share during the gloomy period of Vietnamese stock market in the first ten months of 2010 while other stocks lost between 20% and 50%. The firm, which now holds one third of milk market share in Vietnam, has acquired more small dairy firms in Vietnam and expanded operation to New Zealand. It has also been among top ten firms listed on HOSE winning high credit ratings awards in 2010 (www.baodautu.vn) and become Vietnam's first entry on Asia's 200 Best Under A Billion in 2010 rated by Forbes (www.forbes.com).

In conclusion, there have been a number of debates on which objective a firm should give first priority. In finance perspective, modern finance experts assert that maximising shareholder wealth is superior to other goals of the firm such as stakeholder interest, profit maximisation, survival, etc. However, the firm must parallel this goal with satisfying other important constituencies in order to achieve a sustainable development. These imply that the firm should have good corporate governance to bring in not only the benefits for shareholders but also other stakeholders.


To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:


More from UK Essays

We can help with your essay
Find out more