Hi Joshua,
What are the problems associated with profit maximization? Without knowing these problems it is impossible to determine whether wealth maximization can solve problems of profit maximization. I suppose whatever problems you perceive regarding profit maximization also exist in wealth maximization. Please be a bit more specific.
Thanks Abdol for your input, however, profit maximization has been criticized because it ignores time value of money; it ignores risk and uncertainties; it is vague and it ignores other participants in the firm rather than the shareholders.
Hope this is slightly specific as you suggested.
Hi Joshua,
The first two objections you list can be easily dealt with by discounting future profits (what in the finance literature is known as free cash flows) by using a suitable discount factor, which could include a risk premium. Nevertheless, these objections are equally valid for shareholders' wealth maximization any way.
The third criticism, which in my opinion is a valid one, is also applicable to wealth maximization because both profit and wealth maximization are zero sum games: There exist inherent contradiction in private and public interests, contrary to what Adam Smith suggested.
I hope you find this helpful.
I fully subscribe to Abdol's reply. The third criticism relates to the debate "shareholders versus stakeholders". There is a large body of literature on this issue. A good starting point is chapter 1 (more precisely, section 1.8) in Jean Tirole's "The Theory of Corporate Finance".
Thanks Erik for your input. I will consider what you have suggested.
In an behavioral approach, the key to solve profit maximization issues in order to allow wealth maximization is a study on market response to profit and risk management issues. This cannot be seen as a constant response but as a variable response, and i suspect is branch-specific.
Wealth maximization for listed companies is basically related to expectations, and expectations can be positively or negatively changed by disclosing certain information.
Hi Joshua,
There is a debate in the literature related to the corporate objective function of a company. Weather a company should have a single objective function, and if so should this be directed towards value creation for shareholders or stakeholders. you can find more in “Value maximization and the Corporate Objective Function“, author: Michael Jensen.
http://www.hbs.edu/faculty/Publication%20Files/00-058_f2896ba9-f272-40ca-aa8d-a7645f43a3a9.pdf
We can still ask this question in trying to answer the above question, 'does maximizing profit always entail maximizing shareholder's wealth?' There is a relationship between the two. Bearing in mind the impact or rather the problems of agency theory and the principal - agency theory, we noticed different targets in profit maximization. if profit is maximized, that does not mean that shareholder's wealth has been maximized because increase in profit may not always guarantee increase in earnings per share, even increase in earnings per share alone is not enough to say that shareholder's wealth (value) is being maximized. you may get insight by looking up at 'Rappaport's framework for value creation', 'Copeland,koller and Murrin approach for shareholder value analysis'. Also check whether shareholder's value or wealth can be maximized or enhanced through financial auditing and if the same can apply to profit.
https://www.researchgate.net/publication/303830251_Macroeconomic_Determinants_of_the_Behavior_of_Dhaka_Stock_Exchange_DSE
Article Macroeconomic Determinants of the Behavior of Dhaka Stock Ex...
- Badges
- Science topic
- Similar topics
- Methodology
- Research Methodology
- Research Papers