Business

Limitations of Shareholder Value Assumption

Shareholder wealth is the value provided to the equity owners of a company for management’s ability to increase sales, revenues, and free cashflow. This will lead to an increase in dividends and capital gains for the shareholders. Shareholder wealth maximization may not be an accurate description of managerial behavior and
decisions because:
 Corporate governance is too weak to give shareholders sufficient information or influence to
ensure management maximize shareholder wealth rather than, say, their own emoluments.

It ignores the non-financial goals of shareholders: Family firms, firms with ethical funds holding
shares, and firms with substantial shareholdings in the hands of governmental bodies will be also
required to satisfy non-economic objectives such as sustainability or employment.

It is impossible to verify: Seen in retrospect a board’s decisions may be seen to have failed to
maximize shareholder wealth. Yet this is consistent with a board that wished to maximize shareholder
wealth but whose decisions featured bounded rationality. Also to judge whether wealth was
maximized it would be necessary for the researcher to know the outcomes of all the alternatives the
board ignored.

It may not be a suitable prescription for management because it:

 Ignores the nature of the financial return required: Shareholders receive their wealth from
dividends and from capital growth. They are assumed to be indifferent between the two, but in
practice they may not be due to present income needs and the different tax treatments of income and
capital growth.

Overlooks the power of stakeholders other than shareholders, e.g. increasing shareholder wealth
at the expense of staff benefits may lead to loss of staff and industrial action.

Ignores corporate social responsibility (CSR): Many cultures take the view that profits should be
balanced against the good of society and the natural environment.

Show More

Related Articles

Back to top button

Adblock Detected

Please consider supporting us by disabling your ad blocker