The
tradition theory of the firm is based on the concept of profit maximization.
This theory is however l9imited by so many factors e.g. what are we maximizing?
Is it short term profit or long term profit before tax?
tradition theory of the firm is based on the concept of profit maximization.
This theory is however l9imited by so many factors e.g. what are we maximizing?
Is it short term profit or long term profit before tax?
This
traditional theory is difficult in its distinction of profit and its scope/time
frame of
traditional theory is difficult in its distinction of profit and its scope/time
frame of
such profit. Some other significant short comings f profit
maximization theories are:
1.
it ignores the time value of money as per N1 today better than N1
tomorrow
it ignores the time value of money as per N1 today better than N1
tomorrow
2.
it can only be achieved at the expense
of social responsibility and good employee welfare i.e. if you fail to
pay your workers
it can only be achieved at the expense
of social responsibility and good employee welfare i.e. if you fail to
pay your workers
3.
it ignores the risk and uncertainty involved in making such profits i.e
they look at the profit in absolute figures but not consider the risk of profit
maximization
it ignores the risk and uncertainty involved in making such profits i.e
they look at the profit in absolute figures but not consider the risk of profit
maximization
Some
other theories of financial objectives were developed. These include:
other theories of financial objectives were developed. These include:
(a) the theory of managerial utility (by Williamson)
Williamson argued that due to perfection in the
financial system, manages tends to pursue their own interest rather than the
interest of share holders. Managers seek to maximize their own utility, which
is seen as a function of their expenditure and the level of discretionary
investment
financial system, manages tends to pursue their own interest rather than the
interest of share holders. Managers seek to maximize their own utility, which
is seen as a function of their expenditure and the level of discretionary
investment
However, expenditure cost rises thereby reducing
the profit attributes to shareholders. This always led to an agency problem.
Since the managers are employed as agent of the shareholders.
the profit attributes to shareholders. This always led to an agency problem.
Since the managers are employed as agent of the shareholders.
(b) The behaviour theory
The view of the behaviourist as anchored by Simeon
is based on the process through which decisions are made within the
organization. Simeon argues that an organization is a collection of interest
groups i.e workers, investors, managers, creditors, publics, shareholders, etc
decision have to be agreed upon by all these interested parties, thus he argues
that it is impossible to always achieve the objective of one party (profit maximization)
of shareholders. There would be an element of compromise ion the ways decision
are made such that profit is not just maximized but rather, it must reach a
satisfactory level. In summary, Simeon argued that the objectives of business
is to satisfy all interested parties, especially customers
is based on the process through which decisions are made within the
organization. Simeon argues that an organization is a collection of interest
groups i.e workers, investors, managers, creditors, publics, shareholders, etc
decision have to be agreed upon by all these interested parties, thus he argues
that it is impossible to always achieve the objective of one party (profit maximization)
of shareholders. There would be an element of compromise ion the ways decision
are made such that profit is not just maximized but rather, it must reach a
satisfactory level. In summary, Simeon argued that the objectives of business
is to satisfy all interested parties, especially customers
(c) Sales maximization theory: (Developed by Baumal).
Baumal argues that the objective of the firm is to maximize sales revenue given
a minimum profit level, which could be the average for the industry. Any profit
over and above the average is not strictly necessary to preserve the
willingness of the investors to continue providing capital for the
organization. As a result, once the average profit has been made, all other
interest and parties could strive to achieve their own objectives.
Baumal argues that the objective of the firm is to maximize sales revenue given
a minimum profit level, which could be the average for the industry. Any profit
over and above the average is not strictly necessary to preserve the
willingness of the investors to continue providing capital for the
organization. As a result, once the average profit has been made, all other
interest and parties could strive to achieve their own objectives.
(d) Shareholders wealth maximization/ maximization of
market price theory
market price theory
This is the most important objective theory of
corporate finance. It seeks to maximize the market price of a company stock.
The market price of a company stock will only be maximized if the following are
in place
corporate finance. It seeks to maximize the market price of a company stock.
The market price of a company stock will only be maximized if the following are
in place
I.
Good employer/ employee relationship
Good employer/ employee relationship
II.
Social responsibility
Social responsibility
III.
Sales market share maximization
Sales market share maximization
IV.
Low rate management turnovers
Low rate management turnovers
Advantages
of wealth maximization over profit maximization
of wealth maximization over profit maximization
a.
Wealth maximization recognizes the time value of money while profit
maximization does not
Wealth maximization recognizes the time value of money while profit
maximization does not
b.
Wealth maximization combines both the short and long run survival of the
organization, while profit maximization considers one at a time
Wealth maximization combines both the short and long run survival of the
organization, while profit maximization considers one at a time
c.
Wealth maximization considers the risk and uncertainty inherent in the
business while profit maximization does not
Wealth maximization considers the risk and uncertainty inherent in the
business while profit maximization does not
d.
Wealth maximization tries to satisfy all the inherited parties in the
organization while profit maximization does not
Wealth maximization tries to satisfy all the inherited parties in the
organization while profit maximization does not
Ekanem
t & m Iyaho (1999) below gives the economic analysis of the structure of
profit maximization firm
t & m Iyaho (1999) below gives the economic analysis of the structure of
profit maximization firm