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Globalization of markets
Possible Goals If we were to consider possible fi nancial goals, we might come up with some ideas like the following: • Survive in business. • Avoid fi nancial distress and bankruptcy. • Beat the competition. • Maximize sales or market share. • Minimize costs. • Maximize profi ts. • Maintain steady earnings growth. Th ese are only a few of the goals we could list. Furthermore, each of these possibilities presents problems as a goal for a fi nancial manager.
For example, it’s easy to increase market share or unit sales; all we have to do is lower our prices or relax our credit terms. Similarly, we can always cut costs simply by doing away with things such as research and development. We can avoid bankruptcy by never borrowing any money or taking any risks, and so on. It’s not clear that any of these actions would be in the shareholders’ best interests.
Profi t maximization would probably be the most commonly cited goal, but even this is not a very precise objective. Do we mean profi ts this year? If so, then actions such as deferring main- tenance, letting inventories run down, and other short-run cost-cutting measures tend to increase profi ts now, but these activities aren’t necessarily desirable.
Th e goal of maximizing profi ts may refer to some sort of long-run or average profi ts, but it’s still unclear exactly what this means. First, do we mean something like accounting net income or earnings per share? As we see in more detail in the next chapter, these accounting numbers may have little to do with what is good or bad for the fi rm. Second, what do we mean by the long run? What is the appropriate trade-off between current and future profi ts?
Although the goals we’ve just listed are all diff erent, they fall into two classes. Th e fi rst of these relates to profi tability. Th e goals involving sales, market share, and cost control all relate, at least potentially, to diff erent ways of earning or increasing profi ts. Th e second group, involving bank- ruptcy avoidance, stability, and safety, relate in some way to controlling risk. Unfortunately, these two types of goals are somewhat contradictory. Th e pursuit of profi t normally involves some ele- ment of risk, so it isn’t really possible to maximize both safety and profi t. What we need, therefore, is a goal that encompasses both these factors.
The Goal of Financial Management Th e fi nancial manager in a corporation makes decisions for the shareholders of the fi rm. Given this, instead of listing possible goals for the fi nancial manager, we really need to answer a more fundamental question: From the shareholders’ point of view, what is a good fi nancial manage- ment decision?
If we assume that shareholders buy stock because they seek to gain fi nancially, the answer is obvious: Good decisions increase the value of the stock, and poor decisions decrease it.
Given our observation, it follows that the fi nancial manager acts in the shareholders’ best inter- ests by making decisions that increase the value of the stock. Th e appropriate goal for the fi nancial manager can thus be stated quite easily:
Th e goal of fi nancial management is to maximize the current value per share of existing stock.
Th e goal of maximizing the value of the stock avoids the problems associated with the diff er- ent goals we listed earlier. Th ere is no ambiguity in the criterion, and there is no short-run versus long-run issue. We explicitly mean that our goal is to maximize the current stock value. If this goal