Firms Object

Question 1

What is the main objective of a firm?

Answer 1

The traditional objective is to maximise shareholder wealth, usually measured by the share price.
Share price reflects the present value of future expected cash flows, adjusted for risk and time value of money.
This is preferred over profit because it’s long-term focused and considers more than just short-term earnings.

Question 2

Why not just maximise profit?

Answer 2

Back:
Profit focuses only on short-term accounting numbers, and ignores:
• Timing of cash flows
• Risk
• Cost of capital
• Sustainability
So, a company could show high profits but still destroy shareholder value.
Share price is a better guide because it captures future value and risk.

Question 3

What is the stakeholder view of firm objectives?

Answer 3

Stakeholder theory says firms should care about all stakeholders, not just shareholders.
This includes:
• Employees
• Customers
• Suppliers
• The environment
It argues that focusing on only shareholder wealth can hurt long-term performance and reputation.

Question 4

What is the agency problem and how is it fixed?

Answer 4

The agency problem is a conflict between managers (agents) and shareholders (owners).
Managers might act in their own interest (e.g. empire building, taking fewer risks).
Solutions include:
• Linking pay to performance (bonuses, shares)
• Monitoring (by the board or investors)
• Threat of takeover or being fired