Decision-Making in Finance
Successful decision making in finance requires a deep understanding of the company’s objectives. Managers often apply to a variety of strategies that can ensure successful performance and problem solving within an organization. The most common objective of the firm is to increase the value of the firm’s stock and contribute to the wealth of the owners.
In order words, the firm managers work for enhancing shareholder wealth, which is introduced by the market price of a company’s common stock. In the majority of cases wealth maximization of shareholders and owners is a long-term objective and it states that “…management should seek to maximize the present value of the expected future returns to the owners of the firm” (Moyer et al. 2008, p. 5).
Certainly, firms must also consider other important objectives of an organization, including organizational culture improvement, analysis of retention policies, total quality management, change management, and many other fields. More importantly, managers should also be interested in the welfare of the community in particular and society in general due to the ongoing process of globalization.
Despite possible shortcomings of the established priorities, shareholder or owner wealth maximization should be at the core of management objectives. At the same time, attention should be given to constraints and ethical concerns of increasing stock price and, therefore, managers should find optimal balance while accomplishing the primary goal of financial management.
Advantages and Disadvantages of Shareholder Wealth Maximization
Putting the shareholder wealth maximization at the core of the company’ values and goals creates a number of benefits. To begin with, the goal explicitly analyzes timing and possible risks of the expected benefits produced by stock ownership. Managers must also consider the components of timing and risk management while making significant financial decisions, including capital expenditures (Moyer et al. 2008).
In such a manner, firms can solve problems that can improve shareholder wealth. Further, it is possible to define whether a certain financial decision correlates with the company’s objective.
In case a decision contributes to the augmentation of the market price of the company’s stock, than it can also provide substantial benefits to the welfare of the company’s owners and shareholders. However, in case the action does not meet the established purposes, it should not be implemented.
Because increase in shareholder wealth is an impersonal goal, it can also be considered as a considerable advantage for the firm. Shareholders and owners who disagree with the firm’s policies are eligible to sell their stocks under more beneficial terms as composed to the opportunities under the company’s strategy.
In case an investor has risk preference that is not adjusted by financing, or does not conform to the firm’s decisions, the investor can sell his/her shares at higher price and buy shares in the companies that are able to meet the investor’s requirements (Moyer et al. 2008). Hence, the company should introduce effective strategies and policies that would attract investors and would make them encourage company’s goals at the same time.
With regard to the above objectives, shareholders wealth maximization can be justified as the primary goal in financial management. Nevertheless, social corporate responsibility in business can become the major obstacle for achieving the established goal.
The point is that success of accomplishment of other objectives, as well as the challenges caused by agency relations, may lead to deviations from the firm’s primary objectives. Despite this fact, the shareholders’ wealth maximization objective creates certain patterns and paradigms against which decisions can be considered and, as a result, this objective is accepted in financial management analysis.
Narrow-focused adherence to the maximization of welfare of shareholders and owners is strongly associated with unconstrained shareholder wealth maximization, which, in fact, can result in serious shortcoming for the company. In this respect, Santos et al. (2007) introduce a detailed overview of the constraints that the firm can meet while achieving the shareholder wealth maximization.
The researchers explain that the concern exists because of insufficient data represented on the topic. Therefore, based on agency theory, Santos et al (2007) have proposed their model of increasing the welfare of stakeholders that should rely on a constraint. In other words, much concern should be connected to meeting the goals of all stakeholders involved into business activities of the firm.
In particular, the maximization objectives “…suggest that shareholder wealth maximization should not be achieved at the expense of stakeholders such as employees, environment, local community, creditors, and similar entities” (Santos et al. 2007, p. 110). In such a manner, the presented approach to finance management indirectly influences the ethical standards, as well as social responsibilities in the company.
Realization of constraints of shareholder wealth maximization can significantly enhance ethical curriculum and, therefore, the shortcomings of the objectives should be outlined as well. In this respect, owner’s welfare does not provide distinct relationship between stock price and financial decisions.
The second disadvantage of wealth increase can become a reason for management frustration and anxiety. Such an occurrence can emergence when managers are more concerned with short-term goals of a firm. Therefore, they can often confuse shareholder wealth maximization with the increase in company’s profits.
Therefore, specific attention should be given to the distinctions between these two goals (Shim and Siegel 2008). Hence, profit maximization can constitute a part of owner wealth advancement, but it cannot be considered a priority for the managerial staff.
It is an accepted fact that increase in shareholders’ wealth is prescribed as a relevant function for analyzing capital projects. At the same time, the objective does not represent a description of managers’ genuine objectives. In particular, there is a protracted debate in regard to economic objectives of managerial staff who do not possess controlling shares.
As a result, the possibility of emergence of conflicts of interest between managers and shareholders is obvious. According to Grinyer (1986), “…managers should identify and satisfy at least the minimum requirements of important participants in their company if they wish to ensure its survival” (p. 320). Therefore, most of the managers should approach rationally the wealth maximization.
Nonetheless, rational financial managers would try to increase the net cash flows created by a company, with regard to the limitations that reflect risk, as well as financial requirement of the members of an organization. With regard to the above, it is possible to argue that managers will prefer accumulating more cash to fewer amounts.
Their focus, therefore, will be made on effective operational management. Another important constraint of shareholders’ wealth maximization lies in excess attention to the financial issues which can lead to a failure of accomplishing nonfinancial goals of an organization.
Despite the above-highlighted constraints and shortcomings, much evidence reveals that shareholder wealth increase is the prevailing goal for business corporations. In this respect, Fatemi et al. (1983) introduces a model by means of which the researchers have discovered the priority of business organization, in which the first place is given to the goal of increasing the wealth of owners.
As per the secondary goals, emphasis has been placed on sales maximization, earning smoothing, and liquidity goal (Fatemi et al. 1983).
Ethical Standards Reconsidered
In case a company tries to increase its stock price, much concern should be connected with the benefits it can provide for society. In most of cases, shareholder wealth maximization is generally good, apart from the possibility of illegal actions, such as “…attempting to form monopolies, violating safety codes, and failing to meet pollution control requirements” (Besley and Brigman 2011, p. 168).
Other than that contributes greatly to the welfare of society as well. To achieve this purpose efficiently, stock price maximization must involve efficient plants that manufacture products and services of high quality and at an acceptable price. Further, stock price increase requires product development to meet the customers’ needs.
More importantly, it should also encourage introduction of profit through innovation, namely new technology and new products. Employment sphere should also be managed properly and, therefore, the task of the managers is to ensure competitive salaries. Finally, increase in shareholders’ wealth requires courteous and efficient services, well-situation business establishments and optimal stocks of merchandize.
All the above-mentioned factors are indispensible to maintaining a customer base necessary for producing sales and, therefore, revenues. In addition, in order to sustain a competitive advantage, business activities of an organization must be presented in congruence with all stakeholders, including owners, customers, employees, the government, local residents, and the environment.
Consequently, most activities contributing to stock price maximization are beneficial to society as well. In this respect, free enterprise, profit-motivated economics have produced significant results as compared to communistic and socialistic business systems. Due to the fact that managerial finance is incredibly important in operating firms successfully, which is necessary for a productive and healthy economy, finance is of great importance from social perspective.
While considering the role of shareholder wealth maximization in shaping social welfare, much emphasis should be placed on ethics and morality of financial management. Therefore, it is necessary to define the objective of increasing shareholder wealth from the viewpoint of moral justification for business behavior.
To uncover the ethical perspectives, Dobson (1999) introduces the essential aspects of corporate culture through which it is possible to analyze the morality of shareholder wealth maximization. Specifically, the researcher believes that making decisions premised on stock price increase is morally neutral and that augmentation of shareholders’ wealth could not be regarded as a strictly immoral action.
Within this context, decision making is considered “…a particular moral stance open to moral evaluation” (Dobson 1999, p. 69). In this respect, a financial manager who makes decisions for maximizing stock prices is morally neutral. However, this assumption is popular mostly among financial examinations and is explained by moral self-examination.
As a result, such a narrow-focused method creates a number of limitations to objective evaluation. In this respect, Dobson (1999) argues, “the acceptance and implementation of shareholder wealth maximization as the ultimate goal entails the acceptance and implementation of several layers of philosophical context” (p. 71).
First of all, it implies accepting a specific interpretation of utilitarian theory, in which value is presented as the greatest good and moral decisions within which company can rely solely on the outcomes of those decisions. Consequently, to prefer shareholder wealth maximization is to shape a specific moral environment in a broader context of moral and ethical philosophy.
Utilitarian theory, therefore, produces only one context within a broader one. As an approval of a business behavior, shareholder wealth maximization is justified by business ethicists whose criticism is premised on the fact that “shareholder wealth maximization places preeminent emphasis on the interests of shareholders” (p. 71).
Therefore, though the term shareholder wealth maximization often implies a materialistic interest, it, in fact, emphasizes the importance equity market value discovered through the company’s stock price.
With regard to the above-presented considerations, the concept of shareholder wealth maximization implies that “a finance professional, rather than having to reconcile diverse moral perspectives, can rely on the market mechanism to translate moral concerns into economic signals” (Dobson 1999, p. 74). In other words, the morality of the objective does not depend on the objective itself, but on the personal intentions of the executive agents.
The objectivity of the firm’s intention to maximize the wealth of owners and shareholders is still undermined by the existing standards of ethical behavior. As a result, the action can hardly be defined a priority for maintaining company’s welfare and reputation.
According Chambers and Lacey (1996), “a corporation that embraces SWM does not establish a moral and ethical position but rather merely acts as a conduit for the ethical beliefs and desires of market participants” (p. 93). What is more important is that market price can also reveal ethics, along with other values of a company, including cash flows.
Hence, a corporation that seeks to increase the wealth of its owners and shareholders makes the company’s stocks more attractive for investors. In case investors consider ethical behavior and social corporate responsibility a priority, they will unlikely to finance firm and, as a result, stock prices can become considerably lower. So, an ethical firm have much more possibilities to sustain a competitive environment as compared to unethical firms that care only about profit maximization.
Consideration of social corporate responsibility has a potent impact on deciding whether shareholder wealth maximization is a paramount goal for a business firm. There is also evidence proving positive reaction of world’s market on the company’s announcement of corporate social responsibilities, which means it can also positively influence the company’s profit increases, as well as augmentation of shareholders’ wealth.
According to the research studies, “…firms that experience a positive market reaction are larger, with lower leverage and have a higher level of employee productivity” (Clacher & Hagendorff 2012, p. 265). Because social corporate responsibility promotes ethical behavior and moral orientation of the firm, it is purposeful to state that profit increase can also be a motivating factor for shaping the company’s values. Well-established relationships between stakeholders provide an optimal balance for increasing profits and wealth of the company’s owners.
In a crisis context, shareholder wealth increase may lead to certain behaviors and decisions that contradict duties, such beneficence, reparation and non-maleficence. In this respect, Alpaslan (2009) contrasts shareholder wealth maximization model, which considers social responsibility and ethical concerns a constraint, with corporate governance model, which considers ethical concerns to be an important objective.
In this respect, the researcher stands against shareholder value maximization approach and prefers stakeholder model as a more relevant technique of corporate governance. In addition, Alpaslan (2009) that the objective of maximizations is justified and beneficial for the company unless it violate legal and ethical norms.
However, in a context of a crisis situation, managers often resort to elimination of shareholders’ losses, which does not always meet the purpose of shareholder maximization. Nevertheless, this approach is still paramount for the welfare of the firm because it produces greater good for the company, as well as meets ethical concerns more effectively than the model of corporate governance.
To define the benefits of shareholders’ wealth improvements and its importance for an organization, it is purposeful to compare it with other models of corporate governance. The reasons for choosing stakeholder model are predetermined by a number of reasons.
To begin with, the stakeholder model is more congruent with the principle of fair distribution, which underlines the significance of including all stakeholders in managing company.
Further, stakeholder models acknowledges the concept of ‘non-instrumental ethics’ according to which implies that “…when there is a conflict between the shareholder model and ethical customs or moral principles, ethical customs, ethical customs should dominate” (Alpaslan 2009, p. 42). Finally, the stakeholder model has different norms and, therefore, it opposes to the norms of the shareholder model.
The above is an antagonistic view on the ethicality of shareholder value maximization approach to managing a company. At the same time, the moral neutrality is the argument that still supports the necessity to increase wealth of owners, particular on the threshold of globalization and innovation. Most importantly, the objective is much more effective in creating a competitive advantage and attracting investors.
Conclusions
An in-depth analysis of various aspects and perspectives of financial management has revealed that stakeholder wealth increase should be considered as a priority for a business firm due to a number of reasons. From an ethical perspective, ensuring stakeholders’ wealth creates more opportunities for a firm to encourage profit management and introduce a strong competitive advantage.
Second, stakeholder wealth maximization provides a wider picture of how time and risk management can be arranged with regard to stock prices balancing. Third, focus on shareholders’ welfare allows managers to define whether financial decision correlates with the company’s philosophy.
Despite the fact that the goal is premised on meeting personal interest, it can still be regarded as impersonal objective because owners and shareholders’ intentions directly influence the overall organizational performance.
Apart from the benefits of shareholder wealth increase, there are certain constraints and shortcomings that can be met. This is of particular concern to the problem of social responsibility and ethical behavior, which is often neglected. However, this matter cannot be considered critical because financial managers making decisions are morally and ethically neutral.
Moreover, the objective is subject to utilitarian ethical principles, which defines positive consequences as a priority. Overall, the importance of adhering to the proposed scheme does not only provide welfare to the internal environment, but produces values at an external level.
In particular, owners and shareholders will still follow the ethical models of behavior and introduce effective conditions for other stakeholders, including employees, customers, the government, and environment.
Reference List
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Clacher, I, & Hagendorff, J 2012, ‘Do Announcements About Corporate Social Responsibility Create or Destroy Shareholder Wealth? Evidence from the UK’, Journal Of Business Ethics, 106, 3, pp. 253-266
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