Wealth Maximization Definition with Implication
Wealth Maximization Definition – It refers to maximizing the wealth of shareholders.
Financial theory asserts that the wealth maximization is the single substitute for a stake holder’s utility. When the firm maximizes the shareholder’s wealth, the individual stakeholders can use this wealth to maximize his individual utility. It means that by maximizing stakeholder’s wealth, the firm maximizes stake holder’s utility. A stake solder’s wealth is the product of numbers of shares and the current stock price per share.
Higher the stock price per share, the greater the shareholder’s wealth. Thus a firm should aim at maximizing its current stock price, which helps in increasing the value of shares in the market. To understand Wealth maximization definition, look at the diagram given below.
Formula for Wealth Maximization
Stockholder’s current wealth in the firm = (No. Of shares owned) * (Current stock price per share)
Implication of the wealth maximization
- The wealth maximization is a universal concept because it takes care of interest of financial institution, owners, employees and society at large.
- Wealth maximization guides the management in framing the consistent strong dividend policy to reach maximum returns to the equity holders.
- Wealth maximization objective not only serves the interest of the shareholder’s but also ensures the security to the lenders.
Criticism of wealth maximization
- It is a prescriptive idea. The objective is not descriptive of what the firm actually does.
- The objective of wealth maximization is not necessarily socially desirable.
- There is some controversy as to whether the objective is to maximize the stockholder’s wealth or the wealth of the firm, which includes other financial claim holder’s such as debenture holders, preference shareholders.
- The objective of wealth maximization may also face difficulties when ownership and management are separated, as is the case in most of the corporate form of organizations. When managers act as the agents of the real owner, there is the possibility for a conflict of interest between shareholders and the managerial interests.