Maximizing shareholder wealth as an adequate goal of management in a modern world

Maximizing shareholder wealth as an adequate goal of management in a modern world

Introduction

There are two major approaches in which businesses seek to meet their objectives; these are profit maximization and wealth maximization. In this essay, wealth maximization is explored as business objective which primarily is to maximize on shareholder wealth as the best management approach in the modern world (Starovic, Cooper and Davis, 2004, p 3). Corporate finance theory revolves round the fact that a business entity’s financial managers have the primary endeavor to maximize on the business’ market worth as expected by its shareholders as the most appropriate means to manage operations and adequately realize the creation of wealth on capital invested whether as equity or debt(Madden, 2005, P 12). This is referred to as maximizing shareholder wealth, a modern approach to managing investments and resource utilization as opposed to the traditional approach commonly referred to as profit maximization. It is accredited with portraying a true and fair view of a business entity’s overall performance, promoting professional ethics, enhancing employee productivity and contributes positively to a society’s welfare.

	Financial management approach

 

 

 

 

 

 

 

 

Fig 1.1 Approaches to Finance Management. Sourced (New age publishers, n.d, p 7)

 

Financial management in this context involves planning and instituting control measures over a corporate business’ financial resources with the main aim of ensuring returns are made on capital invested. Maximizing shareholder wealth entails realizing increases in earnings per share and more so ensuring that a business’ net present worth is maximized (Dayananda, et al. 2002, p 3).

http://www.valuebasedmanagement.net/articles_cima_maximizing_shareholder_value.pdf

	Goal of the Firm Maximizing Shareholder wealth   M

 

 

 

 

	Financing decision		Dividend decision		Investment decision

 

 

 

 

 

Capital Budgeting

 

 

 

 

 

 

Fig 1.2 Corporate goal, financial management and capital budgeting. Sourced, (Dayananda, et al. 2002, p 2)

 

Wealth or value can be defined as to be equal to the difference arrived at from the gross present value of a decision or decisions or choice of exploit and the total investment needed to achieve forecasted returns. Gross present value relates to capitalized value of perceived benefits (Starovic, Cooper and Davis, 2004, p 6). The value has to be discounted at a rate dependent on uncertainty or certainty aspects such as taxes and interest rate variations in the forecasted returns. Maximizing shareholder wealth can also be defined as an approach that is expressly concerned with cash flow amounts generated through a specific course of action or decision taken other than profit making (Starovic, Cooper and Davis, 2004, p 6). Thus for wealth creation to be realized, the net present value of a course of action or decision taken has to be greater than zero.

W = V – C

Where    W = Net Present Wealth

V = Gross Present Wealth

C = Capital Outflow

V = E / K

Where      E = Quantity of future benefits

K = Capitalization rate representing risk

and terminal benefits related to E.

E = G- (M +I +T)

Where        G = mean of anticipated future cash inflows

M = mean annual re-investment necessary to sustain G at projected levels in anticipated out flows of yearly payments related to accrued interest and dividends

T = predetermined annual tax outflows

Sourced, (Financial ma