Why Shareholder Wealth Maximization is Important in Business?

In modern finance, it is proven that shareholder wealth maximization is the superior goal of a firm and shareholders are the residual claimants; therefore maximizing shareholder returns usually implies that firms must also satisfy stakeholders such as customers, employees, suppliers, local communities, and the environment first. Also, a firm’s value can not be maximized if the management board or shareholders ignores the interest of its stakeholders. Thus, the main goal of a firm is to maximize shareholder wealth but it does not mean that management should disregard stakeholders.

To begin with, it is necessary to understand what is shareholder wealth and why maximizing shareholder wealth is a superior objective? Maximizing shareholder wealth is defined as maximizing purchasing power as well as the flow of dividends to shareholders through time and it is a long-term perspective. In addition, a very important point to explain why shareholder wealth maximization is superior objective is that shareholders are the real owners of the firm, of course, they desire the company’s operation will create their returns as much as possible; therefore, the management board should make investment and financing decisions with the target of maximizing long-term shareholder wealth.

Thus, with practical reason, shareholder wealth maximization is a precise and clear decision as well as a suitable and operationally feasible goal. Also, shareholder wealth is represented by the market price of a firm’s common stock and stock prices illustrate clearly the magnitude, timing, and risk connected with profits that stockholders hope to get in the future, so management should drive the stock price as high as possible. Furthermore, the greater the risk associated with receiving a future benefit, the lower the value investors place on that benefit. Thus, maximizing the present value of expected future returns to the owners is also the true target for the firm in terms of reaching shareholder wealth maximization and the returns will be represented in forms such as takings of common stock sales as well as healthy periodic dividends.

Shareholder Wealth Maximization Importance in Business

Besides that, it is also important to realize that the goal of maximizing shareholder wealth has some advantages. Firstly, it explicitly considers the time value of money and risk factors of the benefits expected to receive to the owners. In other words, the elements of timing and risk must be considered by managers as they make an important financial decision, for example, capital expenditures. Secondly, if a firm has a decision that can make the market price increasing, it is a good decision. On in other hands, if it does not achieve the effective result, this should not be taken (at least not voluntarily). Finally, maximizing shareholder wealth is an impersonal aim. If stockholders oppose the company’s policies, they can sell their shares freely and invest their funds in others, however, it is noticeable that the shares should be under more favorable terms than are available under any other strategy. Also, investors will be possible to sell their shares at the best price if they have a consumption pattern as well as risk preference which is not accommodated by the investment, financing, and dividend decisions of that firm. They also can purchase shares in firms that closely meet the investor’s needs.

For all the above reasons, shareholder wealth maximization is the superior objective in financial management. However, in term of theoretical reasons, many studies and financial books have proven that shareholder wealth rests on companies which are willing to build long-term relationships with stakeholders. So, focusing on the interests of stakeholders is the most important objective of the company to maximize shareholder wealth. Also, a firm cannot maximize value if it ignores the interests of its stakeholders.

Firstly, customers can be seen at the top of the hierarchy of stakeholders. They are one of the most important factors and greatest challenges to the primacy of shareholder interests. It is undebatable that no company can create great wealth for its shareholders without a stable and growing revenue base, which can be only reached by having very satisfied and loyal customers. So, a company wants to have an increasingly growing number of customers who are willing to pay money to have its products and services, it forces to meet their satisfaction of product quality, reasonable prices, and good services. In other words, the product or service must be meet or exceeds expectations and is acquired at a price no higher than its perceived value.

Also, the grown in sales by creating value for customers will maximize the firm’s stock price in the form of efficient and courteous service, adequate stocks of merchandise. Therefore, the more volume of products distributed, the more shareholder value increased because of vast profits after selling products and services.

Secondly, employees also are of vital importance in the stakeholder objectives of the shareholders. They are the primary workforce and the potential source of a significant competitive advantage that can create superior value directly. Pursuing the objective of maximizing value for shareholders also maximizes the economic interests of all employees over time, even when management is forced to downsize the company. Thus, they will be faithful and devote all their skills and talent if the company’s management board appreciates their crucial role as well as give the best policies for employees including paying fair wages, maintaining fair hiring practices and safe working conditions, supporting education. In other words, the keys to company success are that it must be the motivation for staff to devote the cream of them.

Conversely, if the company does not give its mind to improving the employees’ lives and spirits, they will not try their best to produce quality products, resulting in the failure in satisfying customers. Consequently, the amount of cash flow is poor, therefore, poor stockholder returns are indisputable.

Furthermore, one factor which will generate unforeseeably great value for a firm is the interests of society as a whole. When businesses take a long-term view, the interests of the owners and society often coincide. Thus, it is absolutely indisputable that social responsibility with local communities and the environment in which the company operating are become an important consideration for the boards of companies, especially large companies, such as the source of supplies, for example, rubber, wood, paper from managed forests as well as protecting the consumers and following the local business legislation. Therefore, the more a firm contributes to social interests, the more value of trademark it generates.

Another important factor that affects directly the company’s business activity is suppliers. Suppliers and supply chain management are both crucial to developing and implementing strategies that generate the highest long-term cash flow. It is clearly acknowledged that suppliers will be stable and reliable partners if the management board has a fair, reasonable treat to them. This is shown in implementing all provisions of contracts as well as pay the bills on time. Furthermore, if a firm depends mostly on imported materials, it is necessary to have a sustainable vendor in order to keep its operation stable.

On in another hand, the positive relationship between a company and suppliers will be cause great damage if it always attempts to get very cheap prices, even below market levels as well as detaining payments as much as possible. Consequently, the company will receive poor quality materials in term of cheap prices and suppliers will stop supplying if they see company’s fraudulent actions such as postpone payments in many times or the firm’s financial resource is limited.

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