Goals of the Firm
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Goals of the firms:
Profit Maximization
Maximization of the Shareholders Wealth
I. Profit Maximization:
Profit maximization stresses the efficient use of capital resources, but it is not specific(or ignore) with respect to the time frame over which the profits are to be measured.
In short- term executives may used different assets to sell-off and turn the cash to increase liquidity on corporate balance sheets and than could easily increase profits. But this short run profit taking strategy is not in the best long-term objective and interest of the owners of the public corporation.
In microeconomics, profit maximization functions largely as a theoretical goal, with economist using different models, charts and tables to prove the case that in free market economy firms behave rationally if they increase or maximize profit based on information.
In this world of economics two(2) distinctive elements of business are ignored:
1. uncertainty 2. timing
In reality, different investment projects differ a great deal with respect to risk characteristics, and to ignore these differences in the practice of corporate financing can result in poor management decisions.
In business life there is a very definite relationship between risk and expected return – that is,
private investors demand a higher expected return for taking on the investment projects additional risk.
To ignore this relationship leads to improper decision making to allocate the capital which could lead to long-term conflict between existing investors and management.
II. Maximization of Shareholders Wealth
means maximization of the market value of the existing shareholders common stock price – because the effects of all financial decisions are included.
Private Investors react to poor investment or dividend decisions by selling stocks and causing the total market value of the public shares to fall.
II. Investors can react to good decisions by pushing
up the price of stocks and create wealth for the
shareholder.
If the owners of the corporation are to base financial decisions on a single goal, that goal must be precise,