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DiscussionIssuesandDerivations
1. Whatisthedifferencebetweenstockpricemaximization,firmvaluemaximizationand
stockholderwealthmaximization?
Stockpricemaximizationisthemostrestrictiveofthethreeobjectivefunctions.Itrequiresthat
managerstakedecisionsthatmaximizestockholderwealth,thatbondholdersbefullyprotected
fromexpropriation,thatmarketsbeefficientandthatsocialcostsbenegligible.
Stockholderwealthmaximizationisslightlylessrestrictive,sinceitdoesnotrequirethat
marketsbeefficient.
Firmvaluemaxmizationistheleastrestrictive,sinceitdoesnotrequirethatbondholdersbe
protectedfromexpropriation.
Thus,whenwemaketheargumentthatanactionbyafirm(suchasinvestingorfinancing)
increasesfirmvalue,thisincreaseinfirmvaluewillnecessarilytranslateintoincreasing
stockholderwealthandstockpriceonlyifthemorerestrictiveassumptionshold.Conversely,an
actionthatincreasesthestockpriceinaworldwherethelessrestrictiveassumptionsdonot
hold,maynotnecessarilyincreasefirmvalue.
2. Whatistheobjectivefunctionincorporatefinanceforaprivatefirm?
Theobjectiveofmaximizingstockpricesisarelevantobjectiveonlyforfirmswhichare
publiclytraded.How,then,cancorporatefinanceprinciplesbeadaptedforprivatefirms?For
firmswhicharenotpubliclytraded,theobjectiveindecisionmakingisthemaximizationof
firmvalue.Theinvestment,financinganddividendprincipleswewilldevelopinthechaptersto
comeapplyforbothpubliclytradedfirms,whichfocusonstockprices,andprivatebusinesses,
thatmaximizefirmvalue.Sincefirmvalueisnotobservableandhastobeestimated,what
privatebusinesseswilllackisthefeedback,sometimesunwelcome,thatpubliclytradedfirms
getwhentheymakemajordecisions.
3. Whatistheobjectivefunctionforanonprofitorganization?
Itismuchmoredifficulttoadaptcorporatefinanceprinciplestonotforprofitorganizations,
sincetheirobjectiveisoftentodeliveraserviceinthemostefficientwaypossible,ratherthan
tomakeprofits.Theobjectivethereforehastobestatedintermsofcostefficiency.For
instance,theobjectiveofapublicschoolsystemmightbetodeliveraqualityeducation
(definedintermsofaskillsetthateverygraduateshouldhave)atthelowestcost.Thisdoes
mean,however,thattheskillsethastobebothspecificallydefinedandmeasurable.
4. Aremarketsshortterm?
Therearemanywhobelievethatstockpricemaximizationleadstoashorttermfocusfor
managerseeforinstanceMichaelPortersbookoncompetitivestrategy.Thereasoninggoes
asfollows:Stockpricesaredeterminedbytraders,shortterminvestorsandanalysts,allof
whomholdthestockforshortperiodsandspendtheirtimetryingtoforecastnextquarter's
earnings.Managerswhoconcentrateoncreatinglongtermvalue,ratherthanshorttermresults,
willbepenalizedbymarkets.Mostoftheempiricalevidencethatexistssuggeststhatmarkets
aremuchmorelongtermthantheyaregivencreditfor:
(1)Therearehundredsoffirms,especiallysmallandstartupfirms,whichdonothaveany
currentearningsandcashflows,donotexpecttohaveanyinthenearfuture,butwhicharestill
abletoraisesubstantialamountsofmoneyonthebasisofexpectationsofsuccessinthefuture.
Ifmarketswereinfactasshorttermasthecriticssuggest,thesefirmsshouldbeunabletoraise
fundsinthefirstplace.
(2)Iftheevidencesuggestsanything,itisthatmarketsdonotvaluecurrentearningsandcash
flowsenoughandvaluefutureearningsandcashflowstoomuch.Studiesindicatethatstocks
withlowpriceearningsratios,i.e.,highcurrentearnings,havegenerallybeenunderpriced
relativetostockswithhighpriceearningsratios.
(3)Themarketresponsetoresearchanddevelopmentandinvestmentexpenditureisnot
uniformlynegative,asthe'shortterm'criticswouldleadyoutobelieve.Instead,theresponseis
tempered,withstockprices,onaverage,risingontheannouncementofR&Dandcapital
expenditures.
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5. WhatistheGerman/Japanesealternativetostockholderwealthmaximizationanddoesitwork?
IntheGermanandJapanesesystemsofcorporategovernance,firmsownstakesinotherfirms,
andoftenmakedecisionswhichareinthebestinterestsoftheindustrialgrouptheybelongto,
ratherthanintheirownbestinterests.Inthissystem,theargumentgoes,firmswillkeepaneye
oneachother,ratherthancedingpowertothestockholders.Inadditiontobeingundemocratic
thestockholdersareafteralltheownersofthefirm,itsuggestsaprofoundsuspicionofhow
stockholdersmightusethepoweriftheygetitandisheavilyskewedtowardsmaintainingthe
powerofincumbentmanagers.
Whilethisapproachmayprotectthesystemagainstthewastethatisabyproductof
stockholderactivismandinefficientmarkets,ithasitsowndisadvantages.Industrialgroupsare
inherentlymoreconservativethaninvestorsinallocatingresources,andthusaremuchless
likelytofinancehighriskandventurecapitalinvestmentsbyupstartswhodonotbelongtothe
group.Theotherproblemisthatentiregroupscanbedraggeddownbyindividualfirmsthat
haverunintotrouble.

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