Growing fast


In 1981, Jack Welch made a speech in Hotel Pierre, New York City called 'Growing fast in a slow-growth economy' (dated: 8.12.1981). This is often agreed to as the "dawn" of interest with shareholder value. Welch's stated aim was to be the biggest or second biggest market player, and to return maximum value to stockholders.

Over the century, there has been a sea of change in the concentration towards investor related goals like earning per share, shareholder value etc. A number of studies have been done by many eminent economists so as to prove this fact.

Considering "shareholder wealth maximization", maximizing shareholders wealth means "maximisation of shareholders purchasing power, in an efficient market, it is the maximisation of the current share price."

Creation of shareholders wealth has become the new corporate paradigm. It is considered to be one of the main objectives of companies. Indeed one of the most basic and fundamental tenets of capitalism is the obligation to create and maximize shareholders wealth. Maximization the Shareholders' wealth, which is the heart of economic growth, as a long term proposition delivers higher economic output and prosperity through productivity gains, employment growth and higher wages. Maximization shareholders wealth means maximizing the net worth of the company, and it is depended on performance management.

There has been many misunderstanding that shareholders wealth maximization is same as profit maximization, it might seem like, but that's not the case in all situations, shareholders wealth maximization talks about the value of the company mainly expressed in the form of stock where as profit maximization deals with how much profit the company makes. When investors look at a company they look at both the profit as well as the profit margins, return on capital and other factors of good organization.

For example: Let's take two companies for instance doing the same process. Company A had sales of 50 million pounds and profit of 5 million pounds and company B 100 million pounds and 6 million pounds respectively. It can be easily understood that Company B has less value as compared to company A because company B does not perform as efficiently as Company A. So even though Company B earns more profit than company A, company A will have more shareholder value compared to company B because of the efficient performance of company A.

        One of the other important factors related to investor related goals is the Earning per Share (EPS). According to 'Street Authority', a research-intensive financial publishing firm, "the term earnings per share (EPS) represents the portion of a company's earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period (usually quarterly or annually) by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used."

For Example: Let's take a company, say company A assuming that during the fourth quarter the company had 2 million pounds net income available to shareholders. In the same period, the company had total outstanding share of 5 million. In such a situation, the company's earnings per share would be 0.40 pounds. That is, 2 million pounds divided by 5 million shares = 0.40 of EPS.

Lutz Graf Schwerin von Krosigk, Die grosse Zeit des Feuers (1957), pp. 646-47.

The statement said by Carl Fuerstenberg, a leading German banker of his time, briefly explained one of the principal issues facing the large enterprisethe divergence of interest between corporate management and outside equity shareholders. Do investors have to put their savings in the hands of others, to spend as they wish, with no assurance of getting back any return is a question to be asked? The answers to this question are not as simple as it seems, it involves a complex interaction among legal rules, economic institutions, and market forces. Yet reaching to a viable response is essential for the functioning of a modern economy based upon technology with scale economies that depend on the creation of large companies.

In the U.S., contemporary corporate law is supposed to have as a central objective that is, protection of shareholder interests in the management-controlled firm, and judges have often acknowledged the importance of maximizing shareholder value. An early and famous statement of the principle can be found in Dodge v. Ford Motor Co. (1919): "A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end." Yet another leading contemporary analyst on corporate governance states that "shareholder wealth maximization is usually accepted as the appropriate goal in American business circles."2 Few of the others analysts states that: "There is no longer any serious competitor to the view that corporate law should principally strive to increase long-term shareholder value."3 One of the ways of advancing that objective in the U.S. is to impose trustee duties, and in particular a duty of loyalty, on corporate officers and directors: "Managers must prefer investors' interests to their own in the event of conflict. That is the core of the duty of loyalty."4

But the reality is not so straight forward even in the U.S. Stockholders are said to be the owners of the corporation but they are not considered as the owners of its assets, and they do not have the legal rights to make any decisions directed to the use of those assets.5 This rights wholly lies in the hands of the board of directors, and neither the courts nor the legislatures have been at all precise or consistent in demanding directors trustworthiness to shareholder interest or help the shareholders to assert control over directors. The most important corporate law jurisdiction in the U.S., that is the Supreme court of Delaware has formulated an elaborate theology of deference to board decisions, with but casual regard to maximizing shareholder welfare.6 More than half of the company's Board of Directors in the U.S. have adopted "stakeholder" statutes that allow boards to take into consideration a variety of non stockholder interests, which do not require the shareholders permission to do certain things and thereby enabling them to justify and defend almost any actionnotably resistance to takeovers.7

Moreover, it was when the financial reporting scandals of Enron, WorldCom, Tyco, and other major firms took place, the corporate governance came into play in a more heroic way mainly in the U.S. where in it was only the managements and boards who were more accountable for satisfying their responsibilities to shareholders. Logically, any method used for achieving this accountability should be rooted in a corporation's ultimate goal that is to maximize shareholder value. According to various eminent economists starting with Adam Smith have argued, maximizing long-term value provides a criterion for management decision-making that leads to the most efficient use of society's resources.8

The similar steps have been taken by most of the continental European legislation, mainly few countries like United Kingdom, Germany etc. particularly German corporate law. Under the German law, it is not the exclusive, or even the primary, purpose of the board to protect the interests of the shareholders, but rather to promote the "interests of the firm" ("Unternehmensinteresse").

In an article (Corporate governance and shareholder value: rebuilding trust without stifling enterprise) published by Sir Michael Perry retired Chairman of Centrica, he states in reference to shareholder that as "It's a funny kind of 'ownership' which is all power and rights and no responsibilities. It wouldn't wash in any other sphere of human relationships." It means any responsibilities the company may have are discharged to the shareholders and on their behalf to their appointed board of directors, which is acceptable as far as no disputes arises, but in practice it means that the challenge stops with directors, seldom with shareholders, except when there is a threat on the impacts on the value of their stock.

There has been a remarkable analysis on the concept of profit maximization for a long period of time as reflected in the classic article by Milton Friedman in The New York Times Magazine, "The social responsibility of business is to increase its profits", e.g., Grant (1991), Danley (1991). Based on these facts, the primary objective for developing an ethical analysis of shareholder wealth maximization by establishing a link between the goals of shareholder wealth maximization and profit maximization can be reached at. While there are similarities, the inconsistencies between these two approaches is well illustrated in the classic text by Solomon (1963, chp. 2). In particular, even though there are substantial common characteristics between the two objectives, the traditional microeconomics comes under the goal of profit maximization where there is no uncertainty, the owner of the firm is the decision-maker, there is a fixed capital stock and there is only one period. The variables that are the Price of inputs, the level of production and so on can be well analyzed using this structure. Under appropriate assumptions (e.g. Winch, 1971) profit maximization is consistent with the restricted ethical goal of a Pareto-optimal (functional) allocation of resources.9


According to the statement said by Carl Fuerstenberg one of the prominent German banker, he states that the two key principle issues facing a large enterprise are the divergence of interest between corporate management and outside equity shareholders.

To analysis this statement said by Carl Fuerstenberg, we need to understand what are the challenges a business enterprise face, for this we first need to find out the goals or the objectives that particular enterprise is trying to achieve. According to Carl Fuerstenberg the enterprise will have to go through various hurdles like legal rules, market force, economic institutions etc and still have to reach at the objective or the goal of the enterprise with both satisfying the needs of the shareholders that is "shareholder wealth maximization" and at the same time reach at the company goal that is becoming a global one.

        In various parts of the world like the U.S. for example, the companies are restricted by the corporate law which has its own objective for a company and which have accepted the value of maximizing shareholder value, that is the protection of the shareholder interests in the firm which is been controlled by the members elected by the shareholder. Dodge v. Ford Motor Co. (1919) is one of the greatest examples for this where in Henry Ford the president of "Ford Motor Co.", who was having the majority of the shares said that he would sought to end special dividends to his shareholders so as to develop the company to a higher standard which as disagreed by the minority shareholder "The Dodge Bros." who had 10% of the share, the case went to court and the judge asked the directors of Ford to declare an extra dividend of $19 million, which shows the value of shareholder wealth maximization. But, in argument to this, a few of the eminent analyst states that corporate law should look into a broader sense that is to increase shareholder value on the long run and not for a short period of time as shareholders are also the part owner of the company.

But there is again controversy to this that is, even though it's said that shareholders are also the part owners of a company, it's not so in reality, the shareholders are not given the rights over the assets of the company nor do they have any legal rights to make the decisions related to the use of the assets in the company and the rights wholly lies with the Board of Directors. And in order to prevent the shareholders from demanding for these rights, majority of the company's Board of Directors have adopted "stakeholder" statutes which do not require the shareholders permission to do certain things which justifies their actions (resistance to takeover).

Corporate governance was given more importance once after the financial scandals of various multinational companies like Enron, WorldCom, Tyco etc took place in 2000 - 2001. Corporate governance was given more importance mainly in the U.S after these scandals, where it again states that shareholder wealth maximization should be given more importance and it is wholly the responsibility of the managements and the boards to look into this matter, Adam Smith, a famous economist argues that maximizing long term value (profit maximization) gives a reason for management to make decisions so as to use the shareholders money in a more efficient and systematic way.

We can see various similar steps been taken (to protect the interest of the shareholder) by few of the European countries (like Germany) where it's not the executives nor the primary boards interest which is taken into consideration, but the interest of the shareholder rather than the interest of the firm.

Yet another renowned person Sir Michel Perry former chairman of Centrica says that shareholders ownership of a company is a funny kind of ownership wherein the shareholders have all the rights and powers but they are not responsible for the functioning of the company. For this purpose the shareholders have appointed Board of Directors who works on behalf of the shareholders and who is supposed to work for the benefit of the shareholders. But this is not the case in all the time, the management works for their own benefit or only for the benefit of the company and shareholders are neglected to a great extend which in turn leads to another problem called the 'agency problem'.

According to Milton Friedman an American economist and a public intellectual, in his article published in the New York Times magazine, he says that the responsibility of a good manager is to increase the profits of the company, that is increase the shareholder wealth maximization and at the same time maximizing the profit also (profit maximization).

        Even though Milton Friedman says that both shareholder wealth maximization and profit maximization should go hand in hand, another eminent intellectual states in his text that the aim of profit maximization is suitable only for traditional microeconomics where there is no uncertainty and the decision making is done by the firm or the owner itself and that profit maximization is reliable only where there is limited ethical objective to the efficient allocation of resources.


It can be easily understood that Shareholder wealth maximization has got a significant importance in the corporate world. It is one of the important factors that should be looked into by the managements and the board of directors of a company. In order to maximize this shareholders value, the company should have a bullish market and this valuation is done by two factors that are, Earnings per share of the company and capitalization rate. The company should relatively recognize the rights of shareholders which can be fairly reached at with the help of the various corporate laws and regulations on shareholders' rights and the operation of shareholders' meetings.

The next important factor which the company should look into is the profit maximization where in a firm determines the price and output level derives profit. By focusing on profit maximization, the company can expand itself to a much larger one, diversify so that it's a much greater market exposure, and moreover satisfy the needs and wants of its employees.

Why do you think this has arisen?


Books & Journals:

  1. M. Roe, "The Shareholder Wealth Maximization Norm and Industrial Organization," Vol. 149 (2001), p. 2063.
  2. H. Hansmann and R. Kraakman, "The End of History for Corporate Law," Georgetown Law Journal, Vol. 89 (2001), p. 439.
  3. F. Easterbrook and D. Fischel, "The Economic Structure of Corporate Law" (Cambridge, MA: Harvard University Press, 1991), p. 104;
  4. S. Bainbridge, "Corporation Law and Economics" (Foundation Press, 2002), pp. 419-29.
  5. L. Bebchuk and A. Ferrell, "Federalism and Corporate Law: The Race to Protect Managers from Takeovers," Vol. 99 (1999).
  6. Theodor Baums and Kenneth E. Scott, "Taking Shareholder Protection Seriously? Corporate Governance in the United States and Germany", (2005).
  7. Anant K. Sundaram and Andrew C. Inkpen, "The Corporate Objective Revisited"
  8. Geoffrey Poitras, Journal of Business Ethics; "Shareholder wealth maximization, business ethics and social Responsibility", Feb 1994.
  9. Sir Michael Perry, former Chairman, Centrica, "Corporate governance and shareholder value: rebuilding trust without stifling enterprise" .
  10. Bartley J. Madden, "For Better Corporate Governance, A Shareholder Value Review".
  11. Milton Friedman, "The Social Responsibility of Business Is to Increase its Profits, N.Y. TIMES", Sept. 13, 1970.
  12. CIMA, "Maximising Shareholder Value, Achieving clarity in decision-making".



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