ASSIGNMENT

Assignment



Assignment

Introduction

Many people believe that the primary responsibility of business corporations is to maximize profits. One of the most important arguments for this view is a broadly utilitarian one that says that corporations have this responsibility because profit maximization will lead to an “economically efficient” or “welfare maximizing” outcome. Call this the efficiency argument for profit maximization (EAPM). This argument is politically important, particularly in the United States, and forms part of the implicit background for a great deal of popular and academic theorizing about how corporations should operate. The focus of this assignment will also be on this and will present some arguments in favor and against of this notion while taking into account the statement of Collision (1998:7).

Argument for Profit Maximization

Profit maximization leads to betterment of the overall economy. The basic idea behind the profit maximization is sometimes associated to Adam Smith, but this paper will also focus on the formulation given by Michael Jensen.

Jensen argues that the “objective function” of the firm is “value maximization.” The “objective function” here refers to the goals that a firm is required to promote (Jensen 2002, p. 236). These goals define the normative function of the firm, and they specify the duties of managers, since managers are supposed to manage the firm so that it fulfills its objective function.

“Value maximization” is based on the idea that people often invest in a firm by buying stocks, bonds, warrants, and other financial instruments that are traded in open markets. The “total long run market value” of the firm is equivalent to “the sum of the values of all financial claims on the firm—including equity, debt, preferred stock, and warrants” (2002, p. 236). Value maximization consists in maximizing the total market value of these financial instruments (2002, p. 236). So on Jensen's view, firms are normatively required to maximize the long run market value of the total investment that investors have made in the firm.

Value maximization is closely related to profit maximization. Jensen generally uses the term “profits” to refer to the difference between what consumers pay for the firm's outputs (revenue) and what the firm pays for inputs (costs). Since each of the parties that invests in a firm basically buys a claim on the stream of profits that it generates, the long run market value of the firm is equivalent to the market value of this profit stream: “firm value is simply the long-term market value of th[e] stream of benefits [that the firm produces]” (2002, p. 239).

Value maximization is clearly meant to define a normative requirement for both firms and their managers. The objective function of the firm is not meant to give managers friendly advice or to tell them how best to achieve some objective that they may or may not want to pursue. The objective function of the firm is authoritative. Accounts of the firm's objective function “provide the business equivalent of the medical profession's Hippocratic Oath” (2002, p. 236; see also 2001, ...