Maximizing Shareholder Value: The Role of The Financial Manager

Maximizing Shareholder Value: The Role of the Financial Manager

Today’s business world shows a huge diversification in the shareholders of one company. In most countries, each investor only holds a very small fraction of issued shares by one corporation. This includes also the senior management.

Determining the objectives of the firm is not necessarily a straightforward task because the typical firm will have many types of participants. Among these participants are shareholders, creditors, managers, employees, customers, suppliers, governments and a variety of special interest groups. The objectives of these different types of participants are likely to be in conflict.

But the main focus and objective of every firm and its members should be maximizing value. But whose value should be maximized? It should be shareholders value. The main conflict comes when other members of the firm or other stakeholders try to maximize their own expected wealth. That objective could not be aligned with the main objective of the firm. For example, a manager that runs a not so profitable department will lobby for allocation of funds to his department, even if he knows that those funds could be better off in other department.

Shareholders and the board of directors (designated by shareholders) appoint the management team that will be in charge of managing the firm in the most efficient way and meeting with shareholder expectations and interests. From the perspective of shareholders, the managerial function is simply to maximize shareholder wealth, thus they are expected to act on behalf of the interests of shareholders.

Considering the separation between ownership and control, it is necessary to think about how shareholders can influence what happens in the corporation and how the corporation is managed. The problem arising is the ‘principal-agent problem’ including agency costs, which sometimes naturally follow.

The issue of a principal hiring an agent to represent his interests is referred to as agency relationship. This means that one person (=agent=manager) is employed to carry out the objective of another person (=principal=stockholder). Furthermore, an agency relationship is established between senior and junior management within a corporation. Agency problems might arise also from this perspective.

The manager’s view

One question that may come up is: Do managers actually act on the best interest of the shareholder? It is possible to establish a set of general goals that the management may expect from their managing position like higher management compensation, job security, maximize company’s profit, maximize market share of the company or even survival of the firm. They can also view their position as a chance to improve their personal status: having a company car or a nice furnished office.

One can argue that the main goal of management is to maximize the value of the firm. But that doesn’t necessarily mean that shareholder value is going to be maximized. Wealth of stockholders could be a function of the value of their stock and the dividends the firm pays for that stock. If management aims at maximizing firm value, it is very likely that they will set a low dividend payout ratio in order to reinvest the most part of their earnings. The dividend payout will be lower than what shareholders would expect. In that sense the view from the shareholders may be in conflict with the view from management.

The agency problem can be solved by the alignment of management’s interests with shareholders interest. A way to do this is to tie managerial compensation not only