Principals

Wealth maximization and profit maximization are two terms common to the business world. While the two may be mistaken to mean the same thing, they are a stark contrast of one other, their underlying principles mostly based on the ideologies of those running the company. They, too, have completely varying effects to both the short term and long term goals of the company. Wealth maximization refers to the efforts put in by the company to ensure increased stocks for the shareholders, by constantly bearing in mind the risks of the business model and ensuring increased market share of the company (WallStreetMojo, n.d). Profit maximization refers to the efforts put in to ensure immediate profits, and is based on the principles of maximized output from minimal input, without bearing in mind the risks of the business model, but with an aim of surviving the cut-throat competition in the business world (WallStreetMojo, n.d). For a company looking at long term growth, which is a view that most companies ought to take up, wealth maximization is imperative.

Agency problems develop because of a conflict of interests between a company’s management and its shareholders. Such conflicts usually occur when one party acts out of self-interest without factoring in the plight of another. WorldCom CEO, in 2001 took used the company assets to procure personal loans of up to $400 million, and failed to report this loan acquisition in the yearly report, details of it only coming out years later when scandals hit the company (Hanks, 2019). Enron shareholders resorted to selling their shares at higher prices due to misinformation on the actual value of the shares, and ended up losing millions later due to fall on the prices of their shares (Hanks, 2019). These conflicts tend to occur in large, already-established companies due to the high value of shares at stake and the tempting prospect of quick financial gain by management and principals.

Aligning the agent’s interest with that of the principles has always been the go-to solution for such conflicts (Kim, 2016). For instance, WorldCom CEO should have been made a partial shareholder in the stocks of the company, which would make him consider, before anything else, the long term growth of the company. This, though, only works to some extent as the large stake agents have in the company would deter their management capabilities, for instance, by making them desist from taking risks which would lead to immediate profit for the company (Kim, 2016). Similarly, stakeholders should not be too bent towards getting personal profit, as in Enron Company and, instead, should all seek the continued growth of the company, barring extreme cases such as the imminent fall of stock prices in the future.

References

Hanks, G. (2019, March 5). Examples of Agency Problems in Financial Markets. Retrieved April 30, 2020, from Chron: https://smallbusiness.chron.com/examples-agency-problems-financial-markets-70962.html

Kim, Y. A. (2016, April 28). The Agency Problem of Lehman Brothers’ Board of Directors. Retrieved April 30, 2020, from Illinois Business Law Journal: https://publish.illinois.edu/illinoisblj/2016/04/28/the-agency-problem-of-lehman-brothers-board-of-directors/

WallStreetMojo. (n.d.). Wealth Maximization vs Profit Maximization. Retrieved Aril 30, 2020, from Wall Street Mojo: https://www.wallstreetmojo.com/wealth-maximization-vs-profit-maximization/