Explain why shareholder wealth maximization should be the overriding objective of management

The key difference between Wealth and Profit Maximization is that Wealth maximization is the company’s long-term objective to increase the value of the stock of the company, thereby increasing shareholder’s wealth to attain the leadership position in the market. In contrast, profit maximization is to increase the capability of earning profits in the short run to make the company survive and grow in the existing competitive market.
Table of Contents Show

What is Wealth Maximization?
What is Profit Maximization?
Key Differences
Comparative Table
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Wealth Maximization consists of activities that manage the financial resources to increase the stakeholders’ value. In contrast, Profit Maximization consists of the activities that manage the financial resources intending to increase the Company’s profitability.

In this article, we look at Wealth vs. Profit Maximization in detail.

What is Wealth Maximization?

The ability of a company to increase the value of its stock for all the stakeholders is referred to as Wealth Maximization. It is a long-term goal and involves multiple external factors like sales, products, services, market share, etc. It assumes the risk. It recognizes the time value of moneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.read more given the business environment of the operating entity. It is mainly concerned with the company’s long-term growth and hence is concerned more about fetching the maximum chunk of the market share to attain a leadership position.

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Source: Wealth Maximization vs Profit Maximization (wallstreetmojo.com)

What is Profit Maximization?

The process of increasing the profit earning capability of the company is referred to as Profit Maximization. It is mainly a short-term goal and is primarily restricted to the accounting analysis of the financial year. It ignores the risk and avoids the time value of money. It primarily concerns the company’s survival and growth in the existing competitive business environment.

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Source: Wealth Maximization vs Profit Maximization (wallstreetmojo.com)

Key Differences

The critical differences between are as follows –

#1 – Wealth Maximization

Wealth MaximizationWealth maximization means the maximization of the shareholder’s wealth as a result of an increase in share price thereby increasing the market capitalization of the company. The share price increase is a direct function of how competitive the company is, its positioning, growth strategy, and how it generates profits.read more is the ability of the company to increase the value for the stakeholders of the company, mainly through an increase in the market price of the company’s share over time. The value depends on several tangible and intangible factors like sales, quality of products or services, etc.
It is mainly achieved throughout the long-term as it requires the company to attain a leadership position, which translates to a larger market share and higher share price, ultimately benefiting all the stakeholders.
To be more specific, the universally accepted goal of a business entity has been to increase the wealth for the shareholders of the company as they are the actual owners of the company who have invested their capital, given the risk inherentInherent Risk is the probability of a defect in the financial statement due to error, omission or misstatement identified during a financial audit. Such a risk arises because of certain factors which are beyond the internal control of the organization.read more in the business of the company with expectations of high returns.

#2 – Profit Maximization

Comparative Table

Basis	Wealth Maximization	Profit Maximization
Definition	It is defined as managing financial resources to increase the value of the company’s stakeholders.	It is defined as the management of financial resources to increase the company’s profit.
Focus	Focuses on increasing the value of the company’s stakeholders in the long term.	Focuses on increasing the profit of the company in the short term.
Risk	It considers the risks and uncertainty inherent in the company’s business model.	It does not consider the risks and uncertainty inherent in the company’s business model.
Usage	It helps achieve a larger value of a company’s worth, which may reflect in the company’s increased market share.	It helps achieve efficiency in the company’s day-to-day operations to make the business profitable.

Conclusion

Profit is the basic building block of a company to accrue capital in the shareholder’s equity. Profit maximization helps the company survive against all the odds of the business and requires some short-term perspective to achieve the same. Though the company can ignore the risk factor in the short term, it can not do the same in the long term as shareholders have invested their money in the company with expectations of getting high returns on their investment.

Wealth Maximization considers the interest concerning shareholders, creditors or lenders, employees, and other stakeholders. Hence, it ensures building up reserves for future growth and expansion, maintaining the market price of the company’s share, and recognizing the value of regular dividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. So, a company can make any number of decisions for maximizing profit, but when it comes to decisions concerning shareholders, then Wealth Maximization is the way to go.