Question 1 (b)
Wealth maximisation as the more comprehensive goal: the stakeholder perspective
7 marks
- Time to write
- About 14 minutes
From an older CBCS paper
Question
Question 1 (b) · 7 marks- Why, from a stakeholder perspective, is wealth maximization regarded as a more comprehensive goal than profit maximization? In what way does it address the various stakeholders' interests?
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Why…?What…?Two asks in one question: answer both. Where it asks why, give reasons, not a description.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Stakeholders and the limits of profit maximisation 2 marks 4 min
- 2 Why wealth maximisation is more comprehensive 2½ marks 4 min
- 3 How it addresses stakeholders, and the agency problem 2½ marks 4 min
- Check: every ask answered, key terms underlined 1 min
Short on time? Trim steps 1–3 evenly rather than skip one: each is capped at its own marks.
Try it first. About 14 minutes for 7 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Why profit maximisation is too narrow. A firm has many stakeholders besides its shareholders: customers, employees, government and society, whose objectives differ and may conflict, and which the manager must reconcile. In this setting profit maximisation is regarded as unrealistic, inappropriate and even immoral: it ignores risk, ignores the financing consequences and the timing of returns, and is vague about which profit is meant.
1Quick cash today: the deal is struck even as the godown behind them crumbles.
Weaknesses of profit maximisationIt ignores the risk of the profits; it ignores the timing of costs and returns.
2Asha weighs time against risk on the scale—and the share price curve climbs behind her.
Strengths of wealth maximisationIts result is visible in the market price of the share.
Why wealth maximisation is more comprehensive
- It takes the long view. Wealth is the present value of all expected future cash flows, adjusted for their timing and risk. Short-term profit gained at the cost of employees, customers or the community (cutting safety, quality or wages) lowers future cash flows and raises risk, and so lowers value; wealth maximisation therefore penalises it.
- It is a normative goal that need not undermine other goals: a finance manager pursuing shareholders' wealth must still weigh the relevant considerations of the other stakeholders.
- It builds risk into decisions, which protects lenders and suppliers, whose claims depend on the firm's survival.
How it addresses the various stakeholders' interests
| Stakeholder | How a value-maximising firm serves them |
|---|---|
| Shareholders | Higher market value of their shares and steady dividends |
| Employees | Long-term success depends on a motivated workforce: fair pay, training, job security |
| Customers | Value depends on lasting demand: quality products at fair prices |
| Lenders and suppliers | A sound financial position and timely payment; less risk of default |
| Government | Regular taxes and compliance with law |
| Society | Responsible conduct (pollution control, product safety) avoids costly regulation and loss of reputation |
The agency problem. Shareholders are the principals and managers their agents; managers may pursue their own goals or "satisfice" instead of maximising wealth, and they also see their role as reconciling the conflicting objectives of the stakeholders. Linking managers' pay to share value aligns the two.
Where the 7 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Stakeholders and the limits of profit maximisation | 2 |
| 2 | Why wealth maximisation is more comprehensive | 2.5 |
| 3 | How it addresses stakeholders, and the agency problem | 2.5 |
| Total | 7 |
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