Importance of Maximising Shareholder Value

Importance of Maximising Shargonholder ValueIntroductionFirms may concord different clinicals to achieve. but in theory, a rigid should vex its accusatorys to increase its treasure for its witnessers. Sh atomic number 18holders ar the owners of a firm. hence according to theory tap bearholders wealthiness is the fundamental mark of a firm. (Watson Head - bodied finance principles and practice 2007)Investors generally expect to earn satisfactory returns on their initiatements as they require increase the value of their investments as much as possible. This is ordinarily persistent by dividend payout and or gravid gains by increase the foodstuff value of the share price. The managers of the company act on behalf of the investors, such(prenominal) as operating day to day activities and making closes within the business. In some opposite track they do have the control of the business entity. How ever, firms may have other object glasss to achieve such as ma ximize of clams, growth and increasing its food markets share. When achieving these impersonals of a firm, conflicts may arise as a proceeds of ordain power and control. Managers may make their decisions on their own interests rather than achieving investors wealth.Discussing the investor colligate goals as described earlier, in theory doings of management should be coherent towards tap shareholders wealth, enhancing the value of the business (Basely Brigham- Essentials of Managerial Finance).Value of the business is measured by valuing firms price of shares. Its requirement to take on maximising of stock prices, and its impact to the investors and the scrimping as a whole simultaneously.Maximising returns is as well as an object lens of a firm. It is go outd by maximising the firms net increases. It is also place be described as a short term objective whilst maximising the value of the company is a coarse term objective for a firm ( pecuniary counseling -Kapla n Publishers 2009). thence it is non necessary, maximising kales as maximising shareholders wealth because in that respect are number of effectiveness problems finish be occurred adapting to an objective of profit maximization. It will be discussed in the latter part of the report.Earnings per share (EPS) is one and only(a) of the main indicators of the firms favorableness and it is a broadly used method measuring firms success, as it is contumacious return to equity in theory (fiscal Management Kaplan Publishers 2009).However, EPS doesnt expose the firms wealth since it is determined by using firms net profits. Therefore EPS is also bell the analogous criticism as profit maximization above which will be discussing in the posterior part of the report.During the ult ten years have seen a much greater emphasis on investor link goals. The conflict of self-control and control push aside be recognised as one of the momentous causes which were alter investors and th e world economy in the past ten years. The incorporated s washbasindals such as Enron, Maxwell and World com which occurred new-fangled past had been lost investors confidence towards capital markets. Therefore its ingrained to consider the ethical conduct and social responsibilities towards shareholder wealth maximisation simultaneously. It can also be said the institutional investors such as insurance companies and bounty funds had also made a important regulate on investor related goals in the recent past. appraise of LiteratureOBJECTIVES OF profit MAXIMISATION check to Watson and Head 2007, whilst individuals manage their own specie lights, the monetary manager involves in managing money flows on behalf of the company, and its owners. In a firm pecuniary management is concerned with taking decisions in three headstone areas which are financing, investing and dividend policy. Watson and Head also mentioned, shareholders wealth maximisation as the primary objective o f the firm and at the same time the domain of other stakeholder groups such as creditors, employees, customers and community are also affected when adapting to a corporate goal. However the firm may adopt one or several objectives in short term whilst its pursued the objective of shareholders wealth maximisation in farsighted term(Basely and Brigham Essentials of Managerial Finance). Therefore it is essential to be considered the other possible objectives in short term as well as long term simultaneously.Reviewing one of the main objectives of profit maximisation, a classic oblige of Milton Friedman in the New York Times cartridge clip 1970The social righteousness of Business is to Increase its profits (Poitras, Geoffrey 1994). Considering classical views of Friedman (1970), return (1991), and Danley(1991), Geoffrey analysed the connection between shareholders wealth maximisation and profit maximisation, as an fundament for establishing an ethical analysis for shareholders we alth maximisation. However, Friedman had a moderate view later relating to the concept of profit maximisation towards social responsibilities. (Pradip N Khandwalla, Management paradigms beyond profit maximisation 2004)While at that place were similarities between these two objectives, Solomon 1963, chp.2 utmostlighted the inconsistencies in his classic article (Poitras, Geoffrey 1994). Considering the above views from different authors, Geoffreys suggestion was Even though there are significant consistencies between these two goals, the goal of profit maximisation has designed for the traditional microstinting environs and for the firms which do not have the conflict of ownership and control. It is also assumed that its applied for the environment where there was no uncertainty and no stock issues( Poitras, Geoffrey, 1994).According to Keown, Martin and Petty, 2008 Lasher 2008 Ross Westerfield, and Jordan 2008, Managers are encouraged to maximize its current stock prices by the shareholder theory, thereof the criticisms are understandable. This approach determines the existence of agency problem towards incentive schemes, as incentives are rewarded with the continuous growth of share price and leads to an unethical demeanour of managers, towards manipulating the firms current stock prices (Daniel, Heck Shaffer).CONFLICT OF OWNERSHIP AND CONTROLThe conflict of ownership and control was first identified by Adam smith (RBS Review 1937) and he suggested that the Director cannot protect the other peoples money with the same way that he protects his money (Tony Howell shareowner ship model versus Stakeholder ship model). Its also mentioned in Tony and Howells article, that the separation of ownership and control make a significant influence for corporate conduct and its deeply discussed by Berle and Means (1932). still La Porta et al. (1999) argued against Berle and Means, and he suggested its different from the large corporations, because the shareholder s of large corporations problematical in corporate governance actively where managers are un grudgeable (Tony and Howell shareholder ship model versus Stakeholder ship model).Winch (1971) suggested the goal of profit maximisation is consistent with the ethical theory of utilitarianism whilst allocating resources under different circumstances. (Poitras, Geoffrey 1994). Having considered Winchs suggestion related to the utilitarian theory and profit maximisation, Geoffreys (1994) view was that, inter temporal behaviour is important for firms and efficient investment has a significant affect towards maximising of profits as a result of uncertain next cash flows. It is also discussed the potential conflict of ownership and control. Therefore Geoffrey (1994) suggested the separation of ownership, the decision makers (managers) and owners (shareholders) are involved to the corporate structure.SHAREHOLDERS Vs STAKEHOLDERSEven though most of the economists and authors grant the theory of shareholder wealth maximisation (Berle and Means, 1932 Friedman, 1962), other authors argued the criticisms of shareholder wealth maximisation. They argued that stockholder Theory encourages the managers to make short term decisions and behave unethically as a result of the influence of the other stakeholders. According to smith (2003) believed shareholder theory is prepared to maximise short term objectives at the expense of long term goals (Daniel, Heck Shaffer daybook of Applied Finance spend 2008). However Daniel, Heck and Shaffer analysed the reasons for the criticism and the misguidance of the shareholders theory in their article about shareholder theory, How Opponents and Proponents Both explicate it Wrong? The misguidance has been occurred as a result of engage a long term objective in shareholder theory. Managers should maximise the prox cash flows and its important to consider the stakeholders accordingly (Jensen, 2002 Sundaram and Inkpen, 2004a). According to fr eeman (1984) a firm should consider both shareholders and stakeholders when making their business decisions. However Daniel, Heck and Shaffer describes that the stakeholder theory determines the same criticism as short term behaviour but the shareholder theory has got the protection for both shareholders and stakeholders in the long run. Therefore stakeholder theory is not predominant to shareholder theory. Daniel, Heck and Shaffer suggested the expected future cash flows to analyse the above scenario and they argued that its essential to undertake all the arbitrary NPV projects to maximise shareholders wealth analysing towards maximising current stock price. If there was a goal of increasing of current share price, managers who are rewarded by incentives may attempt to boost the stock price of the firm. However Jenson (2005) and Danielson and press (2006) argued the struggle to increase or obligate the stock prices by management could be destroyed the long term values of the fir m by manipulation, unethical behaviour, delaying NPV positive projects, reducing or not spending on question and development. Jenson has taken Enron as an example for explaining the above scenario. The management of Enron had hidden their debts through off counterweight sheet activities and by manipulating the company tarradiddles (Daniel, Heck and Shaffer). Therefore Daniel, Heck and Shaffer suggested that its essential to design strategies which are consistent with the objective of increasing future cash flows rather than adopting an objective of increasing of current stock price to maximise the wealth of shareholders.Freeman, Wicks and Parmar (2004) argued that all the recent business scandals are oriented toward ever increasing shareholder value at the expense of other stakeholders (Poitras, Jefforey 1994) aft(prenominal) a number of spunky profile firms collapsed ie Enron, WorldCom and Arthur Anderson in US and Maxwell, Polly Peck, BCCI, Barings bank in UK, its been determ ined the requirement of a profound Corporate Governance (Tony Howell the shareholder ship model versus stakeholder ship model). According to Tony Howell, Corporate Governance has been growing for the past 25 years and the tush for Corporate Governance was placed, after the introduction of Cadbury report in 1992 (UK). Omran et. al.2002 Mills, 1998 Fera, 1997 suggested the vastness of Corporate Governance as a result of the new catch of Institutional Investors to Capital markets, Globalisation of Capital markets, increase of Stakeholder and Shareholder expectations(Tony and Howell). outlineAccording to financial management theory, its assumed that the fundamental objective for a firm is to maximise shareholders wealth (Watson Head 2007). Analysing the suggestions and arguments towards fundamental objective, it can be seen that not only in theory but also in the real world it is essential to maximise the wealth of shareholder.Analysing the objective of profit maximisation, overr iding the classical economics views by Hayek (1960) and Friedman (1970), other authors, Solomon (1963) and Geoffrey (1970) argued about the criticisms associated with the objective of maximisation of profits. The conflict of short term goal of profit maximisation and long term objective of shareholder wealth maximisation can be identified as the main conflict. If a firm adapts to an objective of profit maximisation and the managers are rewarded incentives for achieving it, the agency problem could be arise. Therefore in such a situation managers may take decisions towards their own selfish interests, rather than on shareholders. Achieving their self interest managers may subordinate costs by cutting research and development costs, reducing eccentric control measurements, reduce advertising, using lower quality materials. At the same time the NPV positive projects could also be postponed to reduce their costs to determine more profits in short term. Producing low quality products, losing market share, losing customer trust on their products and finally reducing financial accomplishment could be resulted as a result of using low cost strategies. It may lead the business towards insecure stock prices in long run.The other criticism is profit maximisation does not appraise the associated risks. Therefore managers may undertake higher(prenominal) NPV projects to determine higher returns. However higher the required returns, higher the risk (Peter Atrill Financial Management for Decision Makers, 2008). put on risky projects will result future cash flow problems. However, shareholders are assumed as rational investors who provide finance for firms to invest in future projects. As rational investors they require a commonsense return for their investments. Therefore it can be suggested that objective of profit maximising is different from the wealth maximising.Even though shareholder wealth maximisation is the fundamental, firms are not being able to reject the pr ofit situation goals, because there are stakeholder groups who is interesting about financial activities in a firm. In addition to shareholders, Managers, Employees, Customers, Suppliers, finance providers and the community at large are included in the typical stakeholder group. Therefore its essential to take account of profit maximisation within the firm. As a result of these ternary objectives managers can easily pursue their own interest.In real world, financial statements are used to assess firms executing. However, profits are defined as profit before interest and tax, profit after interest and so on. Therefore the ratio of Earnings per Share is often used quite of profit which is calculated using the net profits and the number of shares issued. Investors unremarkably use EPS as a measurement of valuing stock. EPS is for the most part used as it contains of net income of the firm, and it is also used as an indicator measuring firms future cash flows. Although the disadva ntage is EPS does not determine shareholders wealth. However, firms value should be determined by the future cash flows and the risk also need to be considered which is associated to the cash flow. However as mentioned earlier, profits does not take account of risks. IeReported profit figures such as Biotechnological companies and other new economy ventures have insignificant relationship on its stock prices (Financial Management -Kaplan Publishers, 2009). Therefore, in the short term theres an inconsistence between profit maximisation and increase in stock prices in a firm.According to Smith (1937), Berle and Means (1932) and Geoffrey (1994) the separation of ownership is involved the corporate structure. The conflict was mostly seen during the recent past, following the corporate scandals.According to Maria and William in the article of Privatisation and the Rise of Global Capital Markets (Financial Management winter, 2000) The past years there was significant growth in capital ma rkets valuation, growth in auspices issuance as a result of the privatisation programmes. The impacts of share issue privatisation are increasing market liquidity, pattern of share ownership (ie individualist and institutional investors such as Pension funds and Insurance Companies), and increasing of number of shareholders in many countries. However, globalisation was also affected on firms activities simultaneously. Therefore the firms (ie Enron Maxwell), which had poor Corporate Governance had the possibility to involving in unethical activities such as creative accounting and off balance sheet finance(Financial Management, Kaplan Publishers 2009). At the same time Directors involved in high level of corporate takeover activities, achieving their personal interest such as empire building, large remuneration packages (Financial Management, Kaplan publishers 2009).Further analysis of Stakeholder theory and Shareholder theory by different authors, Jenson 2005) and Daniel and Pres s (2006) argued the criticism of stakeholder theory, whilst Daniel, Heck and Shaffer (2008) and Freeman (1984) argued the grandeur of both shareholder and stakeholder theory. However, it can be suggested that the stakeholders play a significant role towards increasing shareholders value. As an example to motivate employees of the firm, they should be handle in a good manner by rewarding increments, bonuses and so on. Long term employee satisfaction could drive the firm towards higher performance and the development of the business by increasing higher productivity and break up quality of products. Simultaneously, building up a trust among customers and acquire and swear the industry leadership.At the same time shareholders provide finance for firms for its work capital management and noncurrent assets for its future projects. Therefore it can be seen an inter relationship and importance of shareholders and the other stakeholders.According to Peter Atrill, (Financial Management for Decision makers , 2008)In the early years financial management theory was primarily developed as part of accounting and the suggestions and arguments were based on periodic observations rather than theoretical frame work. But after the number of high profile firms collapsed, the requirement of corporate governance occurred. Number of committees met and discussed to improve the Corporate Governance and the main concern was the conflict between shareholders interest and managers. Enron was the one-seventh largest listed company in US when its collapsed in 2001 as a result of manipulation of financial statements. Its affected to shareholders, more than 20000 employees worldwide, creditors and customers (Janis Sarra St Johns Law Review Enrons rebound in Canada). The 11 titled Sarbanes Oxley make up 2002CONLUSIONBy analysing the review of literature, it can be suggested that its essential to maximise shareholder value rather than maximising profits alone. However maximising profi t is also can be defined as a performance measurement of a wholesome business. Extremes of profit maximisation can also be caused unethical behaviour of management towards its shareholders and stakeholders.Although, Earnings per Share inconsistent with the long term value of shareholder, its still can be used as a performance measurement, since its got firms net profit.As a result of recent corporate scandals such as Enron, WorldCom and Arthur Anderson, shareholders and other stakeholder groups had given much emphasis on corporate behaviour. The unethical and illegal behaviour of those high profiled firms were lost investor confidence of capital markets. They identified the importance of Corporate Governance which provides the road map for managers to follow, prosecute different objectives towards the firm (Basley Brigham). At the same time the arrival of Sarbanes Oxley Act 2002 provided investors a much more confidence and strength towards capital markets.However, stakeholders ar e also important for firms. They are also treated well for the to maintain a Even there are conflicts between stakeholder theory and Shareholder theory, its necessary to balance these two theories.According to Cathy Haywards article (Black hole sums Financial Management May 2003), during the period of May 2003 the pension funds in US and UK were in a bad condition. According to the assessment of field of study Association of Pension Funds, there was a recede in UK pension funds by more than 250 million in 2002. Its being told that there were many reasons for the crisis but, the huge drop in stock market during the economic down turn 2000-2003 has mainly been affected. The pensions funds are heavily calculate on the dividend payments and the stability of the equity markets, as a result of the drop in share prices the pensions funds struggled to meet their obligations.ReferencesBesley Brigham Essentials of Managerial FinanceDaniel, Heck Shaffer ledger of Applied Finance Fall Wi nter 2008 Shareholder theory, How Opponents and Proponents Both Get it Wrong?Denzil Watson Antony Head Corporate Finance (electronic resource) principles and practice 2007Management paradigms beyond profit maximisation Colloquium a debate by S K Chakraboty, Verghese Kurien, Jittu Singh, Mrityunjay Athreya, Arun Maira, Anu Aga, and Anil K Gupta.Maria K. Boutchkova William L. Megginson Privatisation and Rise of Global Capital Markets , Financial Management Winter, 2000, p31-76Peter Atrill Financial Management for Decision Makers 5th pas seul 2008 (electronic resource)Poitras, Geoffrey Share Holder wealth Maximisation, Business ethics and social responsibility, Journal of Business Ethics feb 199413,2ABI/INFORM Global pg125Rebecca Stratling The Legitamacy of Corporate Social Responsibility Corporate Ownership and Control heap 4 Issue 4, pass 2007Tony Ike Nwanji, Kerry E. Howell A review of the two main competing models of Corporate Governance The Shareholder ship model versus th e Stakeholder ship model Corporate Ownership and Control, Volume 5, Issue 1, Fall 2007