Publicly traded companies use a variety of strategies to increase the price of their stocks. The goal is the same – to make the stock more attractive to investors. One way to do this is through shareholder wealth maximization, the other is to do this through company profit maximization. Understanding shareholders' wealth maximization vs. profit maximization will help you understand the motives of companies you have invested in or are thinking of investing in.
Read More: Difference Between Equity & Profits
Video of the Day
Many corporate boards of publicly traded companies operate with the goal of maximizing shareholder value. For example, if the company makes a large profit one year and has a choice between giving its employees a bonus or paying its shareholders dividends, the company will likely pay the dividends. Another example would be a profitable company sending its production offshore to decrease local labor costs and increase its profits, dividends and share prices.
This view of corporate governance puts shareholders first, ahead of customers, employees, vendors, suppliers, the public and state and local governments. This doesn't mean that the company won't fix dangerous working conditions because it cares more about shareholders than workers, but it does mean that once it's met the minimum legal obligations to other stakeholders, the company focuses on increasing the value of shareholders' stock.
Read More: Financial Lit: Dividends
Company Profit Maximization
Profit maximization refers to the profits that the company, not the shareholders, makes. Shareholders typically don't get profits – they get an increase in their stock value (price) and dividends, known as capital gains. The word "profit" refers to a company having more income than expenses. That amount that's leftover is called a profit. In some cases, "profit" refers to quick stock gains for short-term investors.
Companies that strive for profit maximization look to increase the attractiveness of the company's stock, sending its value (price) higher. That's a key profit and wealth maximization difference, and a way for you to differentiate profit maximization and wealth maximization.
People invest for either short-term or long-term wealth. Short-term investors are looking for quick profits. Long-term investors, such as those saving for retirement, want to increase their wealth over time. When a company's stock increases in price, shareholders' wealth increases. When companies pay a dividend, investors increase their wealth.
Read More: How Does a Shareholder Get Paid?
It’s a Balancing Act
A better term for profit maximization would be "profit optimization." If a company truly wanted to maximize its profits, it wouldn't pay dividends. It would keep that money in the company. Additionally, companies that pursue profit maximization do that in combination with shareholder wealth maximization (or more accurately, optimization).
For many years, corporate America has put shareholder wealth as its main goal, explains Forbes magazine. One rationale for this being acceptable was because the wealthy are job-creators and they would spend their money creating new jobs and "trickling down" their wealth.
As the media has focused more on the growing gap in wages and wealth between the "1 percent" and the middle class and working class, this corporate governance model is losing favor. It's not just about fairness. The more money the middle and working classes have, the more they will spend, stimulating the economy and corporate profits and decreasing pressure on governments to raise taxes and provide entitlements.