According to the maximization model, there are three types of maximization in a company, which are shareholder maximization, stakeholder-owner maximization and total stakeholder maximization. Shareholder wealth maximization is a particular case of stakeholder-owner maximization, where only the pure owner interest as supplier of risk-capital is considered in the maximization. The stakeholder-owner has particular resources and interests which are important for the commitment of other stakeholders and thus for the economic performance of the venture as a whole and for the distribution of stakeholder benefits. Examples of such stakeholder-owners would include managers within the company who were also shareholders or suppliers who had an interest in the ownership of the company. Total stakeholder maximization includes the advantages for all groups, such as employees, local communities, shareholders, suppliers, customers, investors and partners.
Among the three maximization of a company, shareholder wealth maximization plays a significant role and indeed more important than the other two, which are stakeholder-owner maximization and total stakeholder maximization. Many assume that total stakeholder maximization is the most important maximization for a company, yet in reality, such maximization is not easy to achieve. Under the new field of corporate social responsibility, many company are encourage to take the interests of all stakeholder (not only shareholder) into consideration during their decision making process. This is a process where the conflict of interest between shareholder and stakeholder eventually happen. For example, if the general public is part of the stakeholder considered under corporate social responsibility (CSR) governance, a conflict might occur when the company decide to carry out operation that would increase the profit of the company, specifically shareholder but at the mean time the operation may cause more pollution to the environment, which is at the disadvantage of the public (the stakeholder). In short, total stakeholder maximization can be hard to achieve as a profit and earning for a group of the stakeholder (shareholder) can sometime be the disadvantage and loss of another group of stakeholder (group other than shareholder) or vice-versa.
The general type of maximization that companies pursue is stakeholder-owner maximization. Maximization of shareholder value is actually a special case of stakeholder-owner maximization. Under restrictive assumptions, the shareholder maximization is larger or equal to stakeholder-owner maximization. Generally, the main objective of most companies is to maximize its value to its shareholders. Value is represented by the market price of the company’s common stocks, which is a reflection of the firm’s investment, financing, and dividend decisions. Otherwise, the companies should minimize the risk to shareholders for a given rate of return. In reality, companies are more concern about shareholder wealth maximization as this is what the company is portraying to the public. Take an example, if a company focus more on its stakeholder-owner maximization rather than the shareholder wealth maximization, the shareholder (including general public who own an amount of the stock of the company) may gain less or no profit and in some cases even suffer a loss. In this situation, it can bring a negative influence to the perspective of others towards the company which will then lower the value of the company and in the long run, curbs the development of the company.
The shareholder wealth maximization theory presumed that the firm should try to maximize the return to shareholders, as measured by the total of capital gains and dividends, for a certain level of risk. On the other hand, the firm should minimize the risk to shareholders for a given rate of return. The shareholder wealth maximization model assumes as a universal truth that the stock market is efficient. The share price is always correct because it reflects the expectations of return and risk as perceived by investors. It quickly incorporates new information into the share price. Share prices, in turn, are considered as the best allocators of capital in the macro economy. The shareholder wealth maximization model also treats its definition of risk as a universal truth. Risk is defined as the added risk that the firm’s shares bring to a diversified portfolio. The total operational risk of the firm can be eliminated through portfolio diversification by the investors. Therefore, this unsystematic risk, as known as diversifiable risk, the risk of the individual security, should not be a prime concern for management unless it increases the prospect of bankruptcy. Systematic risk, as known as non-diversifiable risk, the risk of the market in general, cannot be eliminated. This reflects risk that the share price will be a function of the stock market.
In conclusion, shareholder wealth maximization is more important than the others. This is because shareholders are solely the holder that finance a company or provide finance for a company development. However, stakeholder-owner maximization too must be taken into consideration as they may be the human resources or the resources that mainly contribute to the performance of a company.
Is Shareholder Wealth Maximization Immoral?
A company that implements shareholder wealth maximization indicates that its goal of management is strive to maximize the return in term of capital gain and dividend paid to its shareholders.
The ultimate objective of all activity within the firm is the maximization of shareholder wealth. However, financial economists should be increasingly aware of growing dissent from, or at least equivocation on, that standard finance definition of corporate objectives.
The idea in shareholder wealth maximization model is that shareholders are the group that take the greatest risks and thus deserves special treatment is a fiction.
In shareholder wealth maximization model, managers make decision on the basis of stock price maximization. The first myth is that making decisions on the basis of stock price maximization is amoral, that is morally value neutral. The second myth is one commonly held by business ethicists, namely, that decisions premised on shareholder wealth maximization are strictly immoral.
The myth that making decision on the basis of stock price maximization is morally value neutral held by financial economists because belief in it can exempt them from any moral self-examination. Shareholder wealth maximization serves as a conduit of ethics rather than a net determinant of ethical behavior.
Besides, every firm strive to pursue shareholder wealth maximization leads to maximum aggregate economic benefit, they think that it’s not just benefit to the shareholder but also the society. This will come about as scarce resources are directed to their most productive use by businesses competing to create wealth. The implication of such a defense is that shareholder wealth maximization is morally neutral. In addition, a manager acting in accordance with shareholder wealth maximization is not exercising any particular moral judgment. For example, the manager makes decision that act in the interests of whoever has the greatest economic influence on the company’s stock price.
On the other hand, the business ethics literature clearly rejects shareholder wealth maximization as an ultimate justification for decisions in business, and they apparently proffer some more ethereal, less material ultimate justification as an alternative.
Besides, as a justification for behavior, shareholder wealth maximization is rarely sanctioned by business ethicists because this model just emphasis on the interests of shareholders. This model focuses on the equity market value which is revealed in the company’s stock price. A manager pursuing shareholder wealth maximization is concerned with anything that affects the company value. In fact, stock price is increasingly being determined by a series of intangible factors such as employee relations, credit quality, environment sensitivity, product reliability, cultural sensitivity and whatever society values.
A management group that is insensitive to the needs and concerns of stakeholders will not flourish financially and, of course, a company that does not flourish financially will not be able to help stakeholders. So, shareholder wealth maximization is not morally neutral and not simply immoral. It neither favors strictly material objectives, nor does it unfairly favor stockholder over other stakeholders.
In accepting shareholder wealth maximization as the objectives, business professional should not abrogate all moral common sense when making any decisions. Only through sound moral judgment on the part of individual managers can the organizational premise of shareholder wealth maximization be morally justified.