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Print this chapterGoals of Financial Management
In this chapter, we will explain the goal of financial management. It is essential to always know the end goal when contemplating various strategies and making financial decisions. If a company focuses only on quality and makes a great product but does not make money, can they stay in business? If managers act to improve their own wealth, what happens to the future value of the corporation?
Maximizing Shareholder and Market Value
A goal of financial management can be to maximize shareholder wealth by paying dividends and/or causing the market value to increase.
LEARNING OBJECTIVE
Describe the relationship between shareholder value and market value
KEY POINTS
- One interpretation of proper financial management is that theagentsare oriented toward thebenefitof theprincipals,shareholders, and in increasing their wealth by payingdividendsand/or causing thestockprice ormarket valueto increase.
- The idea of maximizing market value is related to the idea of maximizing shareholder value, as market value is the price at which anassetwould trade in a competitive auction setting; for example, returning value to the shareholders if they decide to sell shares or if the firm decides to sell.
- There are many different models ofcorporate governancearound the world. These differ according to the variety ofcapitalismin which they are embedded. The Anglo-American (US and UK) "model" tends to emphasize theinterestsof shareholders.
- The sole concentration on shareholder value has been criticized, for concern that a management decision can maximize shareholder value while lowering the welfare of otherstakeholders. Additionally, short-term focus on shareholder value can be detrimental to long-term shareholder value.
TERMS
- shareholder
One who owns shares of stock.
- market value
The total value of the company as traded in the market. Calculated by multiplying the number of shares outstanding by the price per share.
- principal
One who directs another (the agent) to act on one's behalf.
Introduction
Financial management is concerned with financial matters for the practical significance of the numbers, asking: what do the figures mean? There are several goals of financial management, one of which is maximizing shareholder and market value.
Maximizing Shareholder Value
The idea of maximizing shareholder value comes from interpretations of the role of corporate governance. Corporate governance involves regulatory and market mechanisms and the roles and relationships between a company's management, its board, its shareholders, other stakeholders, and the goals by which the corporation is governed.
In large firms where there is a separation of ownership and management and no controlling shareholder, the principal–agent issue arises between upper-management (the "agent") and shareholders (the "principals"). The danger arises that, rather than overseeing management on behalf of shareholders, the board of directors may become insulated from shareholders and beholden to management.
Thus, one interpretation of proper financial management is that the agents are oriented toward the benefit of the principals - shareholders - in increasing their wealth by paying dividends and/or causing the stock price or market value to increase.
Maximizing Market Value
The idea of maximizing market value is related to the idea of maximizing shareholder value, as market value is the price at which an asset would trade in a competitive auction setting; for example, returning value to the shareholders if they decide to sell shares or if the firm decides to sell.
There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The Anglo-American (US and UK) "model" tends to emphasize the interests of shareholders.
The sole concentration on shareholder value has been widely criticized, particularly after the late-2000s financial crisis, where attention has risen to the concern that a management decision can maximize shareholder value while lowering the welfare of other stakeholders. Additionally, short-term focus on shareholder value can be detrimental to long-term shareholder value.
