Why Shareholder Wealth Maximization Despite Other Objectives

The Harvard Law School Forum on Corporate Governance and Financial Regulation 2018-05-23

Posted by S.P. Kothari (MIT Sloan School of Management), on Wednesday, May 23, 2018
Editor's Note: S.P. Kothari is the Gordon Y. Billard Professor of Accounting and Finance at MIT Sloan School of Management. This post is based on a recent paper authored by Professor Kothari; Richard Frankel, Beverly & James Hance Professor of Accounting at Washington University in Saint Louis Olin Business School; and Luo Zuo, Associate Professor of Accounting at Cornell University SC Johnson College of Business.

The view that firms (managers) behave as if their goal is to increase shareholder wealth is the shareholder-wealth-maximization principle. While many might agree this principle governs managerial behavior, it continues to arouse intense scrutiny, adoration, and condemnation. We begin by summarizing the economic rationale behind and the welfare consequences of managers pursuing this principle. Numerous writings articulate the principle, including the influential Friedman (1970) and Jensen (2001). Friedman (1970) encapsulates the principle by imploring managers as shareholders’ agents to “conduct the business in accordance with their desires, which will generally be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”