Why is wealth maximization so important

The concept requires a company's management team to continually search for the highest possible returns on funds invested in the business, while mitigating any associated risk of loss.

This calls for a detailed analysis of the cash flows associated with each prospective investment, as well as constant attention to the strategic direction of the organization. The most direct evidence of wealth maximization is changes in the price of a company's shares.

For example, if a company spends funds to develop valuable new intellectual property , the investment community is likely to recognize the future positive cash flows associated with this new property by bidding up the price of the company's shares. Similar reactions may occur if a business reports continuing increases in cash flow or profits. The concept of wealth maximization has been criticized, since it tends to drive a company to take actions that are not always in the best interests of its stakeholders , such as suppliers , employees , and local communities.

Wealth or Value of a business is defined as the market price of the capital invested by shareholders. It is a combination of two words viz. A wealth of a shareholder maximizes when the net worth of a company maximizes.

This is because wealth maximization is also known as net worth maximization. Finance managers are the agents of shareholders and their job is to look after the interest of the shareholders. The objective of any shareholder or investor would be a good return on their capital and safety of their capital.

Both these objectives are well served by wealth maximization as a decision criterion for business. Wealth is said to be generated by any financial decision if the present value of future cash flows relevant to that decision is greater than the costs incurred to undertake that activity. In essence, it is the net present value NPV of a financial decision. Wealth maximization model is a superior model because it obviates all the drawbacks of profit maximization as a goal of a financial decision.

Positive and higher EVA would increase the wealth of the shareholders and thereby create value. In summary, the wealth maximization as an objective to financial management and other business decisions enables the shareholders to achieve their objectives and therefore is superior to profit maximization.

For financial managers, it is a decision criterion being used for all the decisions. For more clarity, refer Profit Maximization vs. Forgot Password? Article by Madhuri Thakur. What is Wealth Maximization?

Explanation Finance managers serve a principal-agent relationship with the shareholders Shareholders A shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company.

The ownership percentage depends on the number of shares they hold against the company's total shares. The expectation of every shareholder or investor in a company would be to generate a good amount of return from their investment and to safeguard their invested amount too.

The truth is that a company can be both profitable and socially responsible. Consider the Great Recession and one of its main causes; the subprime mortgage crisis. Theses banks were more concerned about their investment portfolios instead of properly loaning money to customers, which is their charge.

Those investment portfolios were filled with toxic assets, which eventually compromised the operations of many financial institutions and caused the failure of several big banks. As a result, their share prices fell right along with them. In this case, greed and a lack of social concern led to their downfall. On the other hand, after almost failing during the Great Recession, GM turned itself around, repaid its debt, and developed "greener" vehicles.

As a result, it realized an increase in its share price. GM took on the mantle of social responsibility rather than exploiting consumers for financial gain. Business firms cannot exist and profit in the long run without being socially responsible.

Why are business firms not seeking profit rather than an increase in share price? One reason is that profit maximization does not take the concepts of risk and reward into account as shareholder maximization does.

The goal of profit maximization is, at best, a short-term goal of financial management. Actively scan device characteristics for identification.