Why Corporate Finance Focuses on Stock Price Maximization

Much of corporate financial theory is centered on stock price maximization as the sole objective when making decisions. This may seem surprising given the potential side costs listed above, but there are three reasons for the focus on stock price maximization in traditional corporate finance.

Stock prices are the most observable of all measures that can be used to judge the performance of a publicly traded firm. Unlike earnings or sales, which are updated once every quarter or even once every year, stock prices are updated constantly to reflect new information coming out about the firm. Thus, managers receive instantaneous feedback from investors on every action that they take. A good illustration is the response of markets to a firm announcing that it plans to acquire another firm. While managers consistently paint a rosy picture of every acquisition that they plan, the stock price of the acquiring firm drops in roughly half of all acquisitions, suggesting that markets are much more skeptical about managerial claims.

• If investors are rational and markets are efficient, stock prices will reflect the long-term effects of decisions made by the firm. Unlike accounting measures like earnings or sales measures such as market share, which look at the effects on current operations of decisions made by a firm, the value of a stock is a function of the long-term health and prospects of the firm. In a rational market, the stock price is an attempt on the part of investors to measure this value. Even if they err in their estimates, it can be argued that a noisy estimate of long-term value is better than a precise estimate of current earnings.

• Finally, choosing stock price maximization as an objective allows us to make categorical statements about what the best way to pick projects and finance them is.

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Responses

  • dorothy benefield
    Why share price maximization should be the focus of finance?
    8 years ago
  • semhar abrha
    Why corporate finance focuses on stock prices maximization?
    7 years ago
  • Demet
    Why corporate finance focuses on stock price maximization?
    7 years ago

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