Choosing the Right Objective

Let us start with a description of what an objective is, and the purpose it serves in developing theory. An objective specifies what a decision maker is trying to accomplish and by so doing, provides measures that can be used to choose between alternatives. In most firms, it is the managers of the firm, rather than the owners, who make the decisions about where to invest or how to raise funds for an investment. Thus, if stock price maximization is the objective, a manager choosing between two alternatives will choose the one that increases stock price more. In most cases, the objective is stated in terms of maximizing some function or variable, such as profits or growth, or minimizing some function or variable, such as risk or costs.

So why do we need an objective, and if we do need one, why cannot we have several? Let us start with the first question. If an objective is not chosen, there is no systematic way to make the decisions that every business will be confronted with at some point in time. For instance, without an objective, how can Disney's managers decide whether the investment in a new theme park is a good one? There would be a menu of approaches for picking projects, ranging from reasonable ones like maximizing return on investment to obscure ones like maximizing the size of the firm, and no statements could be made about their relative value. Consequently, three managers looking at the same project may come to three separate conclusions about it.

If we choose multiple objectives, we are faced with a different problem. A theory developed around multiple objectives of equal weight will create quandaries when it comes to making decisions. To illustrate, assume that a firm chooses as its objectives maximizing market share and maximizing current earnings. If a project increases market share and current earnings, the firm will face no problems, but what if the project being analyzed increases market share while reducing current earnings? The firm should not invest in the project if the current earnings objective is considered, but it should invest in it based upon the market share objective. If objectives are prioritized, we are faced with the same stark choices as in the choice of a single objective. Should the top priority be the maximization of current earnings or should it be maximizing market share? Since there is no gain, therefore, from having multiple objectives, and developing theory becomes much more difficult, we would argue that there should be only one objective.

There are a number of different objectives that a firm can choose between, when it comes to decision making. How will we know whether the objective that we have chosen is the 'right' objective? A good objective should have the following characteristics -(a) It is clear and unambiguous. An objective that is ambiguous will lead to decision rules that vary from case to case and from decision-maker to decision-maker. Consider, for instance, a firm that specifies its objective to be increasing growth in the long term. This is an ambiguous objective since it does not answer at least two questions. The first is growth in what variable - Is it in revenue, operating earnings, net income or earnings per share? The second is in the definition of the long term: Is it 3 years, 5 years or a longer period?

(b) It comes with a clear and timely measure that can be used to evaluate the success or failure of decisions. Objectives that sound good but that do not come with a measurement mechanism are likely to fail. For instance, consider a retail firm that defines its objective as "maximizing customer satisfaction". How exactly is customer satisfaction defined and how is it to be measured? If no good mechanism exists for measuring how satisfied customers are with their purchases, not only will managers be unable to make decisions based upon this objective, but stockholders will also have no way of holding them accountable for any decisions that they do make.

(c) It does not create costs for other entities or groups that erase firm-specific benefits and leave society worse off overall. As an example, assume that a tobacco company defines its objective to be revenue growth. Managers of this firm would then be inclined to increase advertising to teenagers, since it will increase sales. Doing so may create significant costs for society that overwhelm any benefits arising from the objective. Some may disagree with the inclusion of social costs and benefits and argue that a business only has a responsibility to its stockholders and not to society. This strikes us as short sighted because the people who own and operate businesses are part of society.

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