Shareholders Wealth Maximization Advantages, Importance, Principle, Model

Advantages of shareholders wealth maximization

The main objective of any organization is to maximize the wealth of the shareholders. It means that the financial decisions should be taken in such a way that the shareholders receive highest combination of dividends and increase in the market price of shares. This concept is also known as Value Maximization or Net Present Worth Maximization. All financial decisions are based on this concept.

Wealth Maximization in Corporate Sense refers to the maximization of a market price of shares. Market price is an indicator of progress, prosperity, profitability, productivity and prospects of a business enterprise. It seems as a Performance Index.

The main objective of any organization is to maximize the wealth of the shareholders. It means that the financial decisions should be taken in such a way that the shareholders receive highest combination of dividends and increase in the market price of shares. This concept is also known as Value Maximization or Net Present Worth Maximization. All financial decisions are based on this concept.

Wealth Maximization in Corporate Sense refers to the maximization of a market price of shares. Market price is an indicator of progress, prosperity, profitability, productivity and prospects of a business enterprise. It seems as a Performance Index.

Concept, dynamics, goals, Principle of shareholders wealth maximization are given in the diagram below.

Image credits © Manoj Patil.

Objective, purpose, model, Importance of shareholders wealth maximization are follows:

1. Measurement of Wealth
2. Market Value of Shares
3. Common Goal
4. 3 D's Of Financial Decisions
5. Shareholder's Expectations

1. Measurement of Wealth

The main Principle of financial management is the Maximization of Shareholders Wealth. Shareholder's Wealth is measured on the basis of economic value. Economic value is based on cash flows and not profit. Economic Value is defined as: “The present value of future cash flows generated by a decision, discounted at appropriate rate of discount which reflects the degree of associated risk“.

2. Market Value of Shares

The future cash flow is estimated for the present value. The present value is the Market price of share. As Shareholder's wealth is equal to the market price of shares held by him, any increase in Market price of shares would result in an increase in Shareholder's Wealth.

3. Common Goal

The Maximization of Shareholder's Wealth is the common goal between the Shareholders and the Management. The recognition of this goal motivates the Management to allocate the available resources in an optimum way.

4. 3 D's Of Financial Decisions

The Maximization of Shareholder's wealth indicates that the Market price of share is related to three basic financial decisions:

• The investment decisions,
• The financing decision,
• The dividend decision.

5. Shareholder's Expectations

Shareholder's expectations are about future cash flows based on current cash flows and projected future growth. The market price of share shows these expectations.