Financial objectives and stakeholders - Profit vs wealth max...

Learning Outcomes

After reading this article, you will be able to distinguish between profit maximisation and shareholder wealth maximisation as financial objectives. You will identify key stakeholder groups, explain potential conflicts, describe the agency problem between ownership and management, and outline how value creation is measured. You will also understand practical mechanisms to align managerial and shareholder interests.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand how financial objectives guide decision-making and interact with stakeholder interests. Focus your revision on the following syllabus areas:

• The distinction between profit maximisation and shareholder wealth maximisation as corporate objectives
• Common financial objectives, including earnings per share growth and value creation
• The relationship between financial objectives, corporate objectives, and overall strategy
• Identification of key stakeholder groups and their objectives
• The potential for conflict between stakeholder objectives
• The agency problem: why managers’ aims may diverge from shareholders’ aims
• Practical approaches to achieving goal congruence: managerial reward schemes and corporate governance codes
• The use of appropriate financial and non-financial performance measures

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which financial objective explicitly considers the risk and timing of returns?
   1. Profit maximisation
   2. Earnings per share growth
   3. Shareholder wealth maximisation
   4. Revenue maximisation

2. Name two examples of stakeholder groups other than shareholders whose objectives may conflict with the company’s main financial goals.

3. What does agency theory seek to explain within a company?

4. How does value creation differ from simply increasing annual accounting profit?

Introduction

Setting clear financial objectives is essential for effective decision-making in any business. While it may seem natural to focus on maximising profit, this approach often ignores key factors affecting long-term success. Most companies instead aim to maximise shareholder wealth—considering the timing, risk, and sustainability of returns.

However, businesses also face diverse groups of stakeholders with varying objectives. These interests may not always align, leading to conflicts that management must resolve. A strong focus on value creation, good governance, and effective incentive structures help align management with shareholder aims and balance the needs of wider stakeholders.

Key Term: profit maximisation
The objective of achieving the highest possible accounting profit within a period, regardless of risk, timing, or the long-term effects on the business.

Key Term: shareholder wealth maximisation
The primary financial objective of a company: to maximise the total long-term value delivered to the company’s equity holders, measured by share price growth and dividends, and consistently accounting for risk and timing.

Financial Objectives: Profit vs Wealth Maximisation

Profit Maximisation

Profit maximisation focuses on maximising accounting profit, often measured annually or over the short term. While this measure is familiar, it has several drawbacks:

• It ignores risk: Very risky strategies can generate high profits one year, but threaten future stability.
• It disregards the timing of returns: £1 profit today is not equivalent to £1 profit in five years’ time.
• It is vulnerable to manipulation: Accounting policies and creative reporting can distort profit figures.
• It may encourage short-term actions: Cost-cutting measures (such as reducing R&D or staff training) can boost profits now but damage long-term competitiveness.

Shareholder Wealth Maximisation

Wealth maximisation recognises that the primary aim should be to maximise the total long-term returns to the owners of the business. It is typically reflected in increases in share price and the payment of dividends.

• This approach considers risk and the timing of returns.
• It focuses on sustainable strategies that the market values positively.
• It encourages management to select investments that exceed the cost of capital, fostering long-term value.

Key Term: value creation
The process of generating returns that exceed the cost of capital, increasing the overall worth of the business to its shareholders.

Other Common Financial Objectives

• Earnings Per Share (EPS) Growth: Aim to increase post-tax earnings per share. While simple to measure, it may still ignore capital cost and risk.
• Value Creation: Explicitly ensures that management invests only in projects that generate returns above the required rate of return.

Comparing Objectives

Profit maximisation and EPS growth are commonly used but have important shortcomings. Shareholder wealth maximisation and value creation are preferred as they take a long-term, risk-adjusted view.

Worked Example 1.1

A company’s manager can either:

1. Cut the staff training budget, raising profit this year by £500,000.
2. Invest £600,000 in product development, reducing this year’s profit but likely to generate future sales and increase the share price.

Which action is likely to be consistent with shareholder wealth maximisation?

Answer:
Option 2. Although it reduces current profit, long-term share price growth from successful development is likely to create more value for shareholders. Short-term cost-cutting may undermine future performance and eventually erode shareholder wealth.

Exam Warning

Do not use ‘profit maximisation’ and 'shareholder wealth maximisation' as synonyms. In ACCA FM, you must show why wealth maximisation—which considers cash, risk, timing, and long-term effects—is the superior objective.

Value Creation and Performance Measurement

Modern businesses use value-based frameworks to ensure decision-making at all levels supports the goal of increasing the company’s value for owners. Classic measures include:

• Economic Value Added (EVA): Net operating profit after tax minus a charge for the cost of capital.
• Total Shareholder Return (TSR): Change in share price plus dividends received over a period.

Both focus attention on generating returns above the company’s required rate.

Key Term: value creation
Generating a level of return higher than the total cost of capital used, thereby increasing the wealth of shareholders.

Stakeholders and Conflicting Objectives

Key Term: stakeholder
Any individual, group, or organisation with an interest in—or affected by—a company’s activities and outcomes.

Stakeholders in a business include:

• Shareholders (owners)
• Company directors and senior managers
• Employees
• Customers
• Suppliers
• Lenders and financiers
• Government, regulators, and the wider community

Each group may have its own objectives. These aims often conflict with the company’s main financial objectives. For example, employees may seek higher wages and job security, while shareholders may demand higher profits and dividends.

Key Term: agency theory
The theory that addresses issues arising when one party (the principal) delegates work to another (the agent), notably where managers (agents) act on behalf of shareholders (principals) and may have divergent objectives.

Stakeholder Objective Conflicts

• Employees vs Shareholders: Requests for higher pay reduce available profit.
• Shareholders vs Lenders: Shareholders may favour riskier growth, lenders prefer security.
• Community vs Company: Environmental regulations may limit cost savings or profit.
• Managers vs Shareholders: Managers may be motivated by personal benefit, not shareholder wealth.

Worked Example 1.2

A business grows rapidly by borrowing heavily, increasing managers’ pay (which is linked to sales size), but as a result, interest costs soar, and profits for shareholders fall below expectations. What is the conflict?

Answer:
Managers’ interests (expanding size and pay) have diverged from shareholders’ primary aim—maximising wealth. This is a classic case of the ‘agency problem’, where agents pursue their own benefit at the owners’ expense.

The Agency Problem and Mechanisms for Alignment

Separation of ownership (shareholders) and control (management) creates an agency problem. Managers may:

• Pursue empire-building for personal reputation
• Take unwise risks or avoid profitable risks unnecessarily
• Manipulate accounts to maximise bonuses

Aligning Interests

Businesses use practical mechanisms to reduce agency costs and align objectives:

• Performance-based incentives: Share options, long-term bonuses, and performance-related pay aligned to share price or value measures.
• Corporate governance codes: Rules requiring independent non-executive directors, separation of CEO and chair roles, and transparent disclosure of director reward.

Worked Example 1.3

If a manager’s bonus is paid for reaching annual profit targets, what risk may arise, and how can this harm shareholder value?

Answer:
Managers might cut costs essential to long-term growth (e.g., research, staff development). This boosts short-term profit—and their bonus—but undermines the company’s sustainable competitive advantage, potentially reducing long-term shareholder returns.

Revision Tip

Review how share-based incentives and strong governance structures support goal congruence—aligning the interests of managers with those of shareholders.

Summary

Profit maximisation provides an incomplete and potentially dangerous guide to decision-making. Shareholder wealth maximisation and value creation better reflect the needs of owners, considering timing, risk, and cash flow. Companies operate within a complex environment of stakeholders—whose objectives may not always agree. Effective reward schemes and governance frameworks are essential to help reduce agency problems and ensure management decision-making remains focused firmly on creating value for shareholders.

Key Point Checklist

This article has covered the following key knowledge points:

• Define and contrast profit maximisation and shareholder wealth maximisation
• Explain why value creation depends on exceeding the cost of capital
• Identify main stakeholder groups and explain the causes of objective conflict
• Describe the agency problem between managers and shareholders
• Outline mechanisms—such as incentive schemes and governance codes—to align management and shareholder interests
• Use value-based and risk-adjusted measures to assess objective achievement

Key Terms and Concepts

• profit maximisation
• shareholder wealth maximisation
• value creation
• stakeholder
• agency theory