The goal of a financial manager is:
1. Selecting value creating projects
2. Making smart financing decisions
However how do we measure the success of a financial manager? Is it maximising profit, reducing expenses or perhaps increasing market share. Well all of the above policies have drawbacks. In maximising profits we have a time issue. A firm can increase its current profit by manipulative accounting decisions or cutting back on research and development. However, clearly these policies are not viable in the long run. Alternatively, a manager could increase profits by cutting dividends and investing in high risk projects. However is this beneficial to the stockholders?
How about increasing market share? This could be achieved by lowering prices or through huge capital expenditures, takeovers and advertising. The cost here can clearly outweigh the benefits of increased volume sales.
Financial Management are therefore required to focus on maximising the current value per share of the existing stock. This avoids the short-run long-run issue as well as avoiding ambiguity in goals. This implies that the firm should aim to conserve cash and, whenever possible, enhance the firm’s power to distribute cash to shareholders. This means that it is more valuable to shareholders to distribute excess cash then wasting it on negative NPV projects
Wealth maximisation is an important concept in finance. It helps govern the choice of projects (i.e. only pursue positive NPV projects) and helps determine the optimal capital structure. However there can be real problems when management choose to act in their own self interest and pursue negative NPV projects. This is known as agency costs. By searching through the corporate finance articles you will find a number of articles dedicated to the costs associated with agency relationships