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Typical Goals of The Firm Include
Typical Goals of The Firm Include
managerial reward maximization; (4) behavioral goals; and (5) social responsibility. Modern
managerial finance theory operates on the assumption that the primary goal of the firm is to
maximize the wealth of its stockholders, which translates into maximizing the price of the firm’s
common stock. The other goals mentioned above also influence a firm’s policy but are less important
than stock price maximization. Note that the traditional goal frequently stressed by economists—
profit maximization—is not sufficient for most firms today. The focus on wealth maximization
continues in the new millennium. Two important trends—the globalization of business and the
increased use of information technology—are providing exciting challenges in terms of increased
profitability and new risks.
Advantages:
1. Easy to calculate profits
2. Easy to determine the link between financial decisions and profits
Disadvantages:
1. Emphasizes the short term
2. Ignores risk or uncertainty
3. Ignores the timing of returns
4. Requires immediate resources
Disadvantages:
1. Offers no clear relationship between financial decisions and stock price
2. Can lead to management anxiety and frustration
3. Can promote aggressive and creative accounting practices
Profit maximization can be achieved in the short term at the expense of the long-term goal,
that is, wealth maximization. For example: a costly investment may experience losses in the
short term but yield substantial profits in the long term. Also, a firm that wants to show a short-
term profit may, for example, postpone major repairs or replacement, although such
postponement is likely to hurt its long-term profitability.
Example
Profit maximization does not consider risk or uncertainty, whereas wealth maximization does.
Consider two products, A and B, and their projected earnings over the next 5 years, as shown
below: