Accounting assignment help on: Shareholder’s objectives and employee values
Friedman Milton’s work provided that profit maximization should be the sole objective of the firms and the firms that have other objectives would sound less competitive and will not be able to provide superior returns to its shareholders, employees and owners. He proposed that the firms which have other objectives would dry up financially in the long run and they would not be able to address their business issues. When Friedman Milton proposed that the primary objective of any enterprise should be to maximize profits, he was talking about the relationship between the managers and shareholders. He meant that the managers must work to maximize the profits so that they can give superior returns to the shareholders. But this approach to management is always looked upon with suspicion and violating the code of ethics. Good firms provide innovative products and services and attempt to solve the consumer’s problems which earlier went unresolved (Christensen & Raynor 2003; Nordhaus 1997). However profit maximization seems to be more appealing in short run but in the long run the firm should aim for wealth maximization. Profit maximization is an implied objective of a firm but here I will try to understand as to whether the firm should go for profit maximization or wealth maximization.
Profit maximization is a subset of a bigger objective of wealth maximization because when we maximize wealth in the long run, profits automatically follows. The debate on which goal is superior (profit maximization or wealth maximization) can go on for hours to months to years but wealth maximization makes more sense as compared to profit maximization because a wealth maximizing firm maintains good relations with every party that it deals with like shareholders, customers, vendors, creditors, government and media. It can have different goals like to increase the revenue, It must comply with the government authorities like tax authorities and must comply with government laws of doing business in a country, also it wants the media to publish positive things about the organization so that they can earn a good name, then doing corporate social responsibilities is another way which can be used to reach out to people and tell them that the company is not only concerned about making money but it also contributes a part of its profits for welfare of the society. However these activities becomes more important when the organizations are operating in the foreign land and satisfies the dominant groups in an economy which are against foreign companies, if foreign company is getting positive acclaim in the society then it gives a shut up call to these dominant groups. A very good example is coca cola, they have made a strong brand presence worldwide that no country can restrict the business in their domestic territory. Coke follows corporate social responsibilities and it has entered into joint ventures with many companies to recycle its plastic bottles all across Europe. They have a target of using 25% of the recycled plastic in their bottles. These activities are silently observed by the public at large and they make a perception about an organization and accordingly support the business to operate on their land (Coca-Cola 2012). Even customers like firms that are ethical and moral and they would refer an organization to their friends and family which is ethical in its conduct and they would love to flaunt their association with such enterprises. This in turn adds to the profitability of the enterprise and also creates wealth for the shareholders.
Friedman’s theory suggests that the managers must work to satisfy every desire of the shareholders, this is a lame argument because the managers are not the servants of the shareholders, it should have been that the managers must work to fulfill all the investment desires of the shareholders and this makes more sense than what Friedman has proposed in his theory. When this view that corporate social responsibility builds the backbone of any organization then Friedman said that the managers have only one responsibility that is to use the resources available and to maximize profits, he even said that corporate social responsibility it unnecessarily beleaguered on the businesses. He had the same views about pollution controlling as he maintained that it is one of the illegitimate responsibilities which the managers have to follow (Heath n.d.).
According to Financial management there can be two objectives of a firm i.e. profit maximization or wealth maximization. Profit maximization is considered as an implied objective, it cannot be the main objective of a firm. Profit maximization is a very myopic view of the management which can lead to certain malpractices like showing exaggerated and exorbitant profits which may not be in tandem with the long term policies of the firm and the shareholders will have to suffer because of that (Moyer et al. 2012).
Wealth maximization is a better and superior objective than profit maximization because a firm which is considered with maximizing shareholders wealth may pay regular dividends because the firm would want to retain its shareholders. It even considers future cash flows, dividends and earnings unlike a firm with profit maximization objective. Investors might not take decisions about the investment in a company only on the basis of past earnings but they also see the potential future earnings of the company which is facilitated by wealth management objective. (Sheeba 2011). Moreover, it sounds much more sensible to keep the objective to maximize shareholders wealth because that takes into consideration all the stakeholders like employees, creditors, customers, debtors and shareholders. When a firm keeps its objective as profit maximization, it sounds as if the firm is desperate to make profits and the customers become apprehensive in buying the firm’s products or services and they feel cheated. A profit maximizing firm may lead to unethical and illegal means just to inflate the profits and to show that the objective is achieved. It does not take into consideration any time frame and does not even specify as to which profits it is considering, whether gross profit, net profit before taxes or net profit after tax. On the other hand wealth maximizing firm does not have a time frame as it has to build on the shareholder value in the long run which is depicted in the market value of the share. So wealth maximization is a long term gain and can be clearly measured from the value of the firm’s shares (Moyer et al. 2012).
Modern companies have a very different approach to business, they do not think their business as different from the society rather they try to look their business with the society as a whole. These days the environment is very dynamic and the corporates have to be concerned with every group linked to the business of the firm i.e. the firm has to pay taxes to maintain good relation with the government and other tax authorities. Wealth maximization means that we are trying to increase the overall value of the firm which increases the value of the shares held by the shareholders. This is very logical because the shareholders would want return on the capital invested by them in the company. If they would not be getting a minimum return on their investment then they would start investing somewhere else.
Traditional approach of financial management was profit maximization and it did not care about shareholder’s value, customers and other interest groups, the only thing they cared about was to make money at any cost. They were neither cautious about environment nor they did anything to restore back what they took from the environment. The textile industry is the biggest source of greenhouse gases because of the numerous processes of treating the cloth at every stage and the water is drained at each stage as it cannot be used further, moreover if this water is not treated properly then it can increase the water pollution. In the earlier approach of profit maximization the companies never cared about treating the factory waste but modern companies are concerned about these issues and they believe in giving back to the environment whatever they take for the production of goods. They have installed water treatment plants so that water can be treated before it is disposed off (Marusiak 2011).
Even on the ethical grounds, the traditional approach of profit maximization seems unscrupulous. There is a conflict of interest in the profit maximization and wealth maximization objective like if we talk about a doctor whose primary objective should be to cure the patient but if there is a patient which can be cured easily by medicines and if the doctor is aiming for profit maximization then he will advise the patient to go for operation because he will make more money in that case. So here it can be seen that profit maximizing objective gives conflicting ideas because the business will not care about anything else but money. (Heath n.d.)
The idea of Corporate Social Responsibility has been in existence since as early as the 19th century. But, it has become much more prominent in today’s time. After the industrial revolution, business leaders like George Cadbury and William Lever started to build towns for the families of factory workers where they had amenities like housing, school, etc as most of the newly developed industrial areas were in slums. George Cadbury founded the town of Bourneville in 1879 in Britain. Companies in United States also started following the concept (Smith 2003). In today’s world Corporate Social Responsibility has become much more prominent with companies emphasizing on creating value through corporate social responsibility. The importance of corporate social responsibility has increased pressures on the organizations to focus their attention towards it. The basic concept of Corporate Social Responsibility is to do to something for the society that you are part of and are utilizing resources of. But it can be argued whether the companies do it just for this reason. Corporate Social Responsibility in today’s time serves the dual purpose of being ethical by doing something beneficial for the society and attracting customers and other stakeholders. Companies find Corporate Social Responsibility to be more compelling because of its benefits on the business particularly as it reduces the reputational risks of the firm and helps it deal with other pressures of the modern business world. For some organizations, corporate social responsibility is unavoidable and they need to follow dedicated strategies to fulfill this need of corporate social responsibility. It can also be noted that following corporate social responsibility may lead to firm’s long term benefit. A study indicates that focus on implementation of corporate social responsibility policies increases the value of the firm (Rossi 2009). Corporate Social Responsibility activities have a positive impact on the firm independent on the economic circumstances. If a firm does not follow proper corporate social responsibilities it may jeopardize its reputation and the firm may lose its appeal to the stakeholders. This would mean a decreasing value of the firm and in turn a decreased value of shareholder’s wealth. This indicates that the objective of corporate social responsibility and shareholder’s wealth maximization can be optimally implemented and achieved together.
Even the employees like to work with companies which are ethically driven and morally concerned and which understands their responsibilities towards the society. If the employees find out that the company is associated with something unethical then they disassociate themselves from the company. Such problems can result in strikes and lockouts, even in these activities employees stand to lose and the share prices can fall because of such problems. Even the media is very vigilant these days in every country if the company is found doing something illegal or unscrupulous or even if some top level executive of the company is found doing some sort of illegal deal, it is flashed in all the television channels that very minute. So the companies should engage themselves with some non-governmental organizations and associate themselves with activities that people want them to do, so that the media can put their rosy picture in front of the consumers and other stakeholders.
Shareholders can get the benefit of maximized wealth by the dividend that the company pays while they own the shares and the proceeds that they get when they sell the share (Moyer et al. 2012). It implies that shareholder’s wealth will be high if the organization earns high profits to be able to give high dividends and if it is valued higher in the market so that shareholders can get a higher price for the shares they own. Even though a firm needs to earn high profits to provide for the high dividends it does not mean the objective of the firm should be profit maximization. Rather a firm should be focused on generating revenue in a way that the dividends are high not just in the present but also in the future. A firm’s focus should be on conducting business that increases the value of its shares.
A firm is held by its shareholder’s. The funds utilized by the company are generated through the capital provided by shareholders. Shareholders are the individuals who have put money in the company and bought its shares, they have the ownership of the company. Since shareholders have put in a part of the wealth in the company they are entitled to gain benefits out of it. There funds enable the organization to work and generate profits. Thus it is important to satisfy the shareholders. Shareholders satisfaction would lie in how much return they get on the funds they have put in as capital. Thus wealth maximization should be the main objective of the firm as it would have no existence without the capital from its shareholders.
After understanding the concept of Wealth Maximization, it is important to understand how the goal of wealth maximization can be achieved. In order to achieve the goal of wealth maximization, the managers need to take decisions that increase the price of the shares held by the shareholders (Brigham & Houston 2009). Any company policy or action that is considered favorable by the public would create a demand for the share increasing the share price. These decisions could be in any form. Company adopting corporate social responsibility and operating in an ethical manner is deemed to sustain in the long run. Thus such actions create positivity in the market increasing shareholder’s wealth by increasing the shares price. But a company that follows its social responsibility and works ethically but makes losses every year would not be considered favorable. Thus there should be a fine balance between all that a company needs to do to sustain itself. A company that shows sign of sustainability and profitability over the years will be the one with increasing shareholder’s wealth. Thus in order to maximize shareholder’s wealth the managers must keep the company in a sustainable position but satisfying all its stakeholders, that is the customers, society, employees, shareholder’s, suppliers, etc.
Friedman Milton’s argument that profit maximization should be the goal of the firm was negated by many researchers who argued that only profits cannot be the parameter of judging the organizational success. There can be many other parameters like customer’s satisfaction, innovation to the market, economic growth, employment generation and adding to the society’s welfare. Even though these parameters provide a barometer of organization’s success, they need to be justified by shareholder’s value creation. A proper approach for an organization shall be where wealth maximization is taken as a primary objective with these parameters acting as secondary objectives that enable achievement of the organization’s primary objective of shareholder’s wealth maximization.
Nothing can compromise shareholder’s wealth maximization objective which means that all these activities like revenue maximization, welfare in the society, compliance to the laws of the land, corporate social responsibilities and maintaining a positive brand image should be in tandem with generation of positive wealth for the shareholders. From this paper it can be understood that wealth maximization is a bigger goal of an organization and profit automatically follows. The organizations should strive to work for long term wealth maximization and should try to satisfy all the interest groups with ethical means. All the ethical and legal obligations should be followed like the customers should be provided with quality products, means the company should not compromise with the quality of products or services just to make more money. This is a better approach as the organization is not just running away with all the profits but they are attempting to pay back to the nation from where they have earned. These small initiatives open the markets in different nations for the companies to operate because of their well-known initiatives and the ethical conduct. Basic understanding is that an organization exists not only to make profits, yes, it is a part of a larger goal but an organization is established to achieve much more than profits maximization. Earning the profits and investing a part on the people who have worked to achieve that goal like employees, creditors and press media.
These days companies are not scrupulous about the society, people and shareholders wealth, they may not even get capital to work because investors remain wary about a company who is planning to get some quick profits, they think that the company might follow some unethical route to fulfill this objective of theirs. The firm should attempt to maximize share prices and not only to give dividends, because share prices reflect not only the past earnings but also the future earnings. So the firm should work for maximizing the share prices so as to increase the shareholder’s wealth. There are many advantages of following a wealth maximizing approach because it gives in concrete as to what it attempts to achieve whereas the profit maximizing approach does not specify the time frame within which it attempts to achieve its objective and also which profit it attempts to maximize i.e. Profit after tax (PAT), Profit before tax (PBT) or operating profits. In totality it was found that every corporate today vouched for wealth maximization objective over profit maximization.
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