Is Objective Of Firms To Maximize Shareholder Wealth Finance Essay - Free Essay Example

Clarifying on the point of what are the objectives of the business is very important to run a business in a purposeful and effective manner. It such as the firm needs to establish what they are trying to achieve and it is also central importance to make choices in business. There are some occasions when manager has to decide which claimants are to have the objectives maximized and which are merely to be satisfied. There are some strong views held on this subject, the left-wing belief that employees should have its rewards maximized and other parties have been satisfied while the pro-capitalist economists believe that maximizing shareholder wealth is the desired objective. From annual report and Financial Statements of Marks and Spencer 2010, it appears that the company doesnt just focus on shareholders; they also build good relations with primary stakeholders like employees, customers, suppliers, local communities and the environment; They tried the best to do the right things cross the business, build a sustainable business through consistent, profitable growth to make sure that their customers and wider stakeholders can trust them to do the right thing. In my points of view, I agree that shareholder wealth maximization should be a superior objective over stakeholder interest and company also should keen on a balanced stakeholder approach. Bellowing are some relevant literature and practical business that support my opinion. Marks Spencer Plc is the leading UKs retailers with over 21 million people visiting its stores each week clarified their objective in its 2006 annual report as our main task to create value for shareholders by developing a trusted brand and delighting customers. Mark and Spencer has a clear idea of its objective. Its mission to deliver economic value to its shareholders through understanding the importance of meeting requirement of existing and potential customers, and the most important customers are the shareholders-the owners of the business. Its objectives, strategies and decisions are toward creating value for them. For almost companies, the largest proportion of long term finance is provided by shareholders. As long as a company performs well and provides them with excellent financial return and opposite. People invest in the expectation that when they sell, the value of each investment will have grown by sufficient amount, above its c ost to compensate them for the risk they took. The relationship between a company and its shareholder is clear. The shareholders give their hard-earned money to the managers of the business in the expectation that they will make good use of the fund. They hope to see substantial return in the form of rising share price as well as a stream of dividend. Glan Arnold, 2008 agreed that the company should make investment and financing decisions with the aim of maximizing long-term shareholder wealth. He also explained through contractual theory that Shareholders are owners of the firm, control its activities. They put money into the business and do not be promised that they will receive a dividend or not. The management board of the firm only promise that will try hardest to produce a return on money. That means the firm may go bankrupt and all money will be lost. The risk that shareholders are taking is not limited, their money may be produced efficiently or it may be reduced, even go to zero. However there are employment contracts between employees and the firm. Employees deal with the firm to provide their services in return for salary and benefit. Suppliers deliver necessary input in return for payment. Customers give money in return for goods and service. Most of the participants bargain for a limited risk, right and a fixed pay off. Because of this unfair balance of risk between claimants on the firms resources, who accepts high risk should be entitled to higher return which result after all the other parties have been satisfied. In Corporate finance principle practice, 2009 Denzil Watson and Antony Head analyzed the relationship between risk and return as high risk parallel with high return. An investor takes on more risk, higher return is offered in compensation. Among relevant claimants of the firm, the shareholders are taking the highest risk of return as mentioned above, so they deserve receiving superior return. On practicalities in a free mark et system, the firm will be difficult and unable to raise more finance from shareholders if it decides to reduce return to shareholders caused by increasing salary to their workers (more interest for employees) or by increasing quality of goods and service for customers (more satisfy and trust from customers) or by paying more for charity, protection environment, ect. Some shareholders will sell their shares and invest to other firms more orientated towards their benefit and concentrate on shareholder wealth creation. According to Pierre Vernimmen (Corporate Finance theory and practice, 2nd edition, 2009) Only creating sustainable value can a company ensure that it has finance growth train, pay to its employees properly, produce quality goods and service and respect the environment. In finance, there is just one overriding objective creating value, only by meeting this objective can one achieve all the others. Marks and Spencer agreed with this theory through their expression in annual report and financial statement 2010. They clarified that their main objective is building a sustainable business through consistent, profitable growth and making sure that their customers and wider stakeholders can always trust them. Cadbury Plc, the world largest confectionery also aims that they should deliver consistent superior return to shareholders in their 2006 annual report: our objective is to consistently deliver superior shareholder returns. We are committed in this objective although we recognize that the company does not operate in isolation. We have clear obligations to consumers, customers and supplier, to our colleagues and to the society, communities and natural environment in which we operate McKinsey and Company (2010) gave explanation for maximizing value of the firm as it is relevant to interest of all stakeholders. Companies that maximize value for their shareholders in the long-term also create more employment, treat the former and current employees better, give their customers more satisfaction, and shoulder a greater burden of corporate responsibility then more shortsighted rival. Competition among value focused companies also helps to ensure that capital, human capital and natural resources are used efficiently cross the economy, leading to higher living standard to everybody. They also argue that value creating company create more jobs, by taking a result of examining employment and found that the US and European companies that created most shareholder value in the past 15 years shown stronger employment growth. Jensen, M.C (2001) cogently argued simple stakeholder balancing or balance scorecard approach to directing a company because of the violation of the proposition that a single financial value objective is a prerequisite and makes society better off. Social welfare is maximized when all firms in an economy maximize total firm value. Value maximization tends to ask managers to make decisions so as to increase total long run market value of the firm. Total value is the sum of the value of all financial claims on the firms including equity, debt, preferred stock, and warrants. So maximizing value of the firm is maximizing value of shares and so on maximizing shareholder wealth. Otherwise, Stakeholder theory extent that firms should pay attention to all their constituencies that can affect the firm. Stakeholders were defined by Freeman (1984) as any group or individual who can affect or is affected by the achievement of an organizations purpose. Managers and board of directors have to choose among multiple completing and inconsistent constituent interests to make sure all stakeholders are at level of satisfaction. Customers want low prices, high quality. Employees want high wage, high quality working conditions and good benefit. Suppliers of capital want low risk and high return. Communities want high charitable contributions, social expenditures by firm to benefit the community at large, sta ble employment, increasing investment and so on. Because of this inconsistent interest group, business needs a balance scorecard as explanation of Kaplan (1996). Freemans definition suggested two-way relationship between a firm and its stakeholders. Stakeholders can affect and can be affected the achievements of a firms objectives. Good stakeholder management has clear instrumental value for the firms, Building better relations with primary stakeholders like employees, customers, suppliers, and communities could lead to increased shareholder wealth by helping firms develop intangible. A case study about short-term financial performance To make sure Marks and Spencer succeed, managers have to get thing right cross business such as being properly to each other as colleague, making sure we feel valued, motivated and rewarded; Treating our customers, suppliers and local community with respect; Respecting environment, involving our employees and customers through Plan A. MS has launched Plan A since 2007 to work with customers and supplier to combat climate change, reduce waste, use sustainable raw material, trade ethically and help customers to lead healthier lifestyles. These are commitment of donating all profit from the sale of single use food carrier bags to environmental charity Groundwork to invest in projects that will improve parks, play areas and public gardens in neighborhoods around the UK, working with Shelter to help make a difference to the many UK families who are homeless or badly housed, with The Prostate Cancer Charity to increase awareness about cancer disease, with The Woodland trust to plant new tr ees, closed lope recycling campaign to reduce waste, MS and Oxfam Clothes Exchange to help save water, protect children from disease, new school books for children. MS believes that if they do the right thing, the right way, their business will be successful; a sustainable business through consistent, profitable growth will be achieved. Their customers and wider stakeholders trust them. At the heart of all is making sure a good return for people who own MS-their shareholders. In other respect, base on point of view of left-wing party, Sumantra Ghoshal (2005) argued that the encouragement of shareholder wealth maximization is wrong. He explained that shareholders do not own the company, have no ownership right on the actual asset, they own a right to the residual cash flow of the company. The value a company creates is produced through a combination the resources of both employees including managers who contribute their human capital and shareholders who contribute financial capital. Employees of a company carry more risk than shareholders because shareholders can sell stocks easier than employees can find another job and employees contribute their knowledge, skill, entrepreneurship that are more important than capital. Then there can be no basic for asserting the principle of shareholders value maximization. However Michael Skapinker pointed out one problem with Ghoshal is that while he demolished shareholder value, he proposed nothing in its place, In general, both theoretical and empirical literatures agree that the goal of a well-run company is maximizing its long-term shareholders wealth as a firm shareholders are the residual claimants. However the firm enjoins every side to strive for friendly long-term relationship with employees, customers, suppliers and bringing benefit to local community and the environment. Objectives of a firm are interdependent. Good management knows which objective or claimant they should focus on each time to achieve long-term purpose is building a sustainable business through consistent, profitable growth and making sure they have a good return for their owners-shareholders. In the real business, many organizations are comfortable with no shareholder wealth maximization as Charity, government department and non-profit organizations.