BUACC2606 Financial Accounting Semester 1, 2012 Assessment weight:25% Due Date:16/05/2012 Week 10 Length:1500 words maximum Group Assignment:2people Format: Report– refer to marking guide attached...

Wealth Maximization

Wealth Maximization




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5/11/2012
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Shareholders vs. Stakeholders
Introduction
Any corporation requires the following basic resources for its existence – land, labor and
other resources, capital and technology. These resources are provided by the society and the
environment at large and thus the company is bound by the obligation of returning these favors
of the society by engaging in activities which seek to maximize the wealth of all the stakeholders
of the company. Assessment of the value of stakeholders is a highly subjective task and as such,
one commonly used metric has been maximization of the value of shareholders of the company
since they are in the capacity of residual claimants over the assets of the company and
maximization of wealth of this group of stakeholders would lead to overall wealth maximization.
The general financial objective of any company has been to maximize the profits of the company
since that would lead to increment of reserves of the company and as such, wealth of the owners
or the shareholders. However, this principle leads to conflicts of interests as has been discussed
under.
Critical Analysis
As per the concepts of traditional finance, maximization of the wealth of the shareholders
was deemed to be the main goal of corporate management. However, this paradigm has been
established on the assumption of classic competitive markets. It was based on the assumption
that all the participants (or stakeholders) who engage in transactions with the firm (i.e. the non
shareholder group of lenders, employees, customers, suppliers, etc) were willing participants in
markets characterized by competitiveness and freedom and these various factors were also fully
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Shareholders vs. Stakeholders
compensated for their services and supplies at fair market prices. The group of shareholders was
classified as a unique group since they lacked prior and explicit claims as they were the owners
of the company and shareholders are treated as residual claimants. Shareholders can achieve
addition to their wealth only after the prior claims of all the stakeholders of the company were
met and the balance profits and losses were attributable to the shareholders. Since the ownership
of the company came at the risk of failure, the rewards of success of the company were also
attributable to the shareholders. This traditional model was based on the simplistic assumption
that there were no costs or benefits related to externalities and no damage and harm was imparted
any non-participant in the activities and transactions of the company. In light of these
assumptions, it was held that the maximization of wealth of shareholders was not just good for
the shareholders, but also benefited the society at large since the wealth of the shareholders’ was
enhanced and created only after the claims of all the stakeholders and the society at large was
fully met and satisfied in a fair and equitable manner (Krishnan, n.d).
The tenets of shareholder wealth maximization were valid only in free markets which are
characterized by perfect competition. But such markets do not exist in the practical world which
makes it difficult for the shareholder theory to hold...