Wealth maximization definition
/What is Wealth Maximization?
Wealth maximization is the concept of increasing the value of a business in order to increase the value of the shares held by its stockholders. 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.
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Problems with Wealth Maximization
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. Here are several examples:
A company minimizes its investment in safety equipment in order to save cash, thereby putting workers at risk.
A company continually pits suppliers against each other in the unmitigated pursuit of the lowest possible parts prices, resulting in some suppliers going out of business.
A company only invests minimal amounts in pollution controls, resulting in environmental damage to the surrounding area.
A company lays off a large number of its employees in order to report higher profits and generate a higher stock price, which devastates the economic condition of the surrounding area.
Because of these types of issues, senior management may find it necessary to back away from the sole pursuit of wealth maximization, and instead pay attention to other issues, as well. The result is likely to be a modest reduction in shareholder wealth. Given the issues noted here, wealth maximization should be considered just one of the goals that a company must attend to, rather than its only goal.