The only legitimate objective of any firm is Maximization of Shareholder Wealth

Topics: Management, Corporate finance, Business ethics Pages: 8 (2234 words) Published: November 21, 2013

1. Introduction

“Corporate finance theory, teaching and the typically recommended practice at least in the US are all built on the premise that the primary goal of a corporation should be the maximization of shareholder value.” (Krishnan, 2009)

One often stumbles upon such statements while reading about shareholders value or maximization of shareholders wealth. This is also a typical answer to questions such as “what is the best and primary objective of a company in a competitive market”. But should it be the only and most important objective in a firm? Must it be fulfilled first and foremost, or is there the possibility of generating more wealth for company, shareholders and stakeholders with other, different approaches? It has to be kept in mind that there are multiple strategies to running a business. One of the strongest opponents of the maximization of shareholder wealth paradigm are the supporters of the so-called stakeholder theory, which claims corporate social responsibility (CSR) and the satisfaction of stakeholders should be the most important objectives for any company.

On the one hand, there is the accepted, popular and traditional paradigm of maximization of shareholder wealth which tries to reach maximization of shareholders wealth with certain management strategies as their main objective. On the other hand there is the stakeholder theory which expresses the worries that the mere focus on shareholders is “often misplaced” (Krishnan, 2008) and that social responsibility and, more importantly, the interests of stakeholders should be the leading objective for a company. Beyond that there are also approaches, introduced by experts of the field that mixes features of both concepts; nevertheless, the majority of the companies prefer either the maximization of shareholder wealth or stakeholder theory as their primary strategy. This research paper aims to figure out if maximization of shareholder wealth is the only legitimate strategy for a firm or whether other approaches – including potentially a mixture of the two main theories of corporate governance – are equally as or more viable to corporate survival in a competitive market. Before any analysis is possible it´s necessary to understand the characteristics and differences between the various options.

2. Shareholder Wealth Maximization Paradigm and Stakeholder Theory

The debate regarding the question which corporate objective is appropriate has its origins back in the 19th century and remains far away from settled. Nevertheless, most businesses, especially in the field of finance, have adapted shareholder value maximization as their management strategy. Textbooks tend to confirm this logic without questioning its usefulness (Sundaram, Inkpen, 2004).

3. General definitions of both approaches

To understand the similarities and differences between these two objectives, it´s important to know how they are essentially defined. Even supporters of the same goal, whether of shareholder wealth maximization or gratification of stakeholder, have different opinions on how they should be construed.

Stakeholder theory was first discussed in detail by R. Edward Freeman in his book “Strategic Management: A Stakeholder Approach”. It identifies stakeholders in a corporation and suggests ways managements can protect their interests. In general, it can be said that the stakeholder theory aims to distribute value and wealth equally among the stakeholders of a firm. The main challenge of this theory is addressing all stakeholders (customers, suppliers, community, etc.) and their various needs equally.

The paradigm of wealth maximization first became very popular during the 1980´s and is based on the principles of competitive free markets. This approach dictates that shareholders receive the remaining revenues after all other claimants of the firm have been paid or satisfied. In Krishans paper (2009), it is stated that this procedure is fair because...
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