Finance

Shareholder Wealth Maximization vs Profit Maximization Objective – Meaning and 10 Differences

Written by Joshua

There are two major objectives of financial management, namely: Shareholders’ wealth maximization and profit maximization.

Before we look at the differences between these two objectives, Let’s define each objective.

Shareholder Wealth Maximization

This is the dominant objective in finance and financial management.

The shareholder wealth maximization objective states that a business should engage in activities that increase its worth and increase the value of its shareholders.

It is concerned with maximizing the returns to shareholders or increasing the values of stocks held by shareholders.

The wealth maximization objective is typically measured by the market value of a company’s shares.

The shareholder’s wealth maximization objective has been advocated for the following reasons:

  1. It is a superior objective to profit maximization as it focuses on the long-term growth and development of the company.
  2. It takes into account the interest of various stakeholders (such as financial institutions, owners, and employees) of the business.
  3. It takes into account the time value of the money concept by discounting cash flows that occurred at different periods using different discount rates
  4. It also considers the risk and uncertainty of cash flows.

On the flip side, the shareholder wealth maximization objective has been criticized for the following reasons:

  • Wealth-maximizing firms face a trade-off between dividend payments and retained earnings.
  • Conflict of interest may arise if the business management (board of directors) is different from its owners (shareholders)
  • There is a trade-off between dividend payment and retaining earnings.

Profit Maximization objective

This is the dominant objective in economics.

According to the profit maximization objective, a business should engage in activities that produce the most profit.

In other words, the profit maximization objective states that a company’s financial actions and decisions should be driven by the desire to make the largest profit possible.

The profit maximization objective is advocated for the following reasons:

  1. It encourages the efficient utilization of resources by encouraging businesses to devote more resources to profitable goods and services and less to unprofitable goods and services
  2. It encourages businesses to work harder and more efficiently.

On the negative side, the profit maximization objective has been criticized on the following grounds:

  1. It ignores the time value of money concept
  2. It does not consider risks and uncertainty associated with cashflows. Profit maximization only considers the largeness of a cashflow. It does not look at the risk involved.
  3. The profit maximization objective is vague since it does not precisely define the type of profit we are maximizing.

Differences Between Wealth Maximization Objective and Profit Maximization Objective

  1. The wealth maximization objective takes into account the time value of the money concept, whereas the profit-maximization objective does not.
  2. Profit maximization is the dominant objective in economics whereas wealth maximization is the dominant objective in financial management.
  3. Profit maximization objective aims to maximize immediate profits, whereas wealth maximization objective aims to increase the value of the company over time.
  4. Wealth maximization objective considers risk and uncertainty associated with cash flows whereas profit maximization does not.
  5. Profit maximization is a short-term objective, as it focuses on maximizing profits in the short-term. On the other hand, the wealth maximization is a long-term objective, as it focuses on increasing the overall value of the company over a longer period of time.
  6. Profit maximization focuses on generating the highest profits possible, even if it means sacrificing other objectives such as customer satisfaction or social responsibility. Wealth maximization, on the other hand, focuses on creating long-term value for the company while also taking into account the interests of other stakeholders, such as customers, employees, and the community.
  7. The profit maximization objective is based on profits, whereas the wealth maximization objective is based on cash flows.
  8. While there is some ambiguity about what profit means in the profit maximization objective, there is none in the wealth maximization objective, which uses cash flow instead of profit.
  9. Profit maximization is measured by the difference between total revenue and total expenses, while wealth maximization is measured by the market value of a company’s shares.
  10. Finally, Wealth maximization is a more modern financial management objective than profit maximization, which is a narrower and more traditional objective of financial management.

Conclusion

The main difference between wealth maximization objective and profit maximization objective is that the wealth maximization objective focuses on increasing the intrinsic value of the company and enhancing the wealth of shareholders over the long term whereas the profit maximization objective focuses on maximizing profit by minimizing costs and maximizing revenue.