Question 1.RQ.2: Why is wealth maximisation viewed as superior to profit maxi...
Why is wealth maximisation viewed as superior to profit maximisation as a business objective?
Wealth maximisation is considered to be superior to profit maximisation for the following reasons:
■ The term ‘profit’ is ambiguous. Different measures of profit can lead to different decisions being made.
■ Profit measures are influenced by the accounting policies and estimates employed.
■ There is a lack of clarity over the time period over which profit should be maximised. There is a potential conflict between short-term and long-term profit.
■ Profit maximisation ignores the issue of risk. This may lead to investments in risky projects in order to gain higher returns. However, this may not align with shareholders’ needs.
■ Profit maximisation fails to take account of the opportunity cost of shareholders’ funds.
Wealth maximisation takes into account risk, the opportunity cost of shareholders’ funds and long-run returns. It is also a more objective measure of performance.