1.10 Issues Relating to the Maximization of Shareholder Value

The first issue relating to the maximization of shareholder value is agency costs. Agency costs are defined as costs that are incurred when management does not act in the best interests of shareholders. Most shareholders (or owners) have delegated the responsibility of running the day-to-day operations of the firm to management. What happens when management has incentives that are different from those of the shareholder? For example, a particular manager might really want to remodel his office on the company’s dime. Does remodeling an office maximize shareholders’ value? Probably not. As a more common example, management might wish to invest capital in particular projects that may not maximize shareholders’ value. A company’s marketing team may come up with an advertising campaign that might improve sales and might even be considered profitable. However, what if capital can be better spent on acquiring new machinery to improve efficiency and, consequently, the bottom line? Agency costs are real costs, and the way that most firms mitigate some of these costs is by aligning managers’ interests with shareholders’ interests. Most commonly, management might be compensated with shares of ownership in the company.

The second issue regarding profit maximization is the potential effect of focusing solely on profits. Is it good for society to have corporations motivated primarily by profit? There are cases when the pursuit of profit has led to unethical behavior by some. For example, one of the most famous cases in ethics happened in 2001, when the Texas-based energy company Enron misreported its financial statements, misled investors, and eventually filed for bankruptcy. Some estimate that more than $10 billion of shareholder value was destroyed because of the scandal. While Enron is an important test case for the unethical maximization of profits, greed and unethical behavior are not always synonymous and should be looked at separately. Think of the benefits that come to society from profitable corporations. Profitable businesses are efficiently providing goods or services that are demanded by the marketplace. Further, profitable businesses are employing other workers and are providing their employees the means to consume goods and services from other businesses in the economy. The employees’ consumption improves the profitability of other businesses, which leads to the hiring of more employees and so on. The benefits that arise from this economy occur because corporations are attempting to maximize profit.