Enterprise Value Maximization

Enterprise Value Maximisation as sole objective of the firm

For more than 200 years economic theory has stressed on using economic value maximization as main objective of the firm which is single mindedly pursued by the management in making every decision for allocation of the resources of the company. And economic theory is unapologetic about it. If every enterprise focus on the creating value then it would help society far more than corporations inefficiently using resources by diverting them under guise of social obligations resulting in non-optimal utilisation of resources by society as whole. 

Stakeholder Theory as offered as superior objective

Stakehoder theory has been recently offered as superior option for allocation of resources of the first which is supposed to provide better objective for benefit of the society as a whole. Stakeholder theory expects management to consider interests of all stakeholders while making decision for allocation of resources. These stake holders include customers, suppliers, employees, society in which company operates and so on. Prima facie it makes management more responsible to the society in which the firm operates and is supposed to benefit society far better than enterprise value maximization by every firm can.  And even management seems to like this.

Unfortunately Stakeholder Theory has too many limitations

Unfortunately stakeholder theory has too many limitations to serve as corporate objective. The greatest challenge of stakeholder theory is lack of measurement. Stakeholder theory emphasizes maximizing benefits of all stakeholders but does not tell how these benefits can be measured. And as Peter Drucker, greatest management thinker would say what you can not measure you can not improve. And what is use of theory which may appear esoteric but can’t improve the workings of corporation, let alone maximize value creation for society as a whole. There are further challenges in ensuring how claims of stakeholders like customers or suppliers are addressed. Does it mean paying higher prices for the supplier which can lead to inefficient operation by supplier which would hurt economy as a whole. Ditto for customers. So ultimately stakeholder theory only offers great promises without anything to act on. And many management’s like it since it helps them to avoid their responsibilities by not having clearly measurable performance. 

Enterprise Value Maximization also has measurement challenges

Of course measurement of Enterprise Value has also challenges. Its taken to be total of value of equity, long term debt less cash in the books assuming cash cannot be used for creating value. And value of equity is taken as market capitalization assuming efficient market theory which believes that share prices by reflecting all the information values firms most accurately. However given volatility in the market which moves more like pendulum rather than weighing scale, market value can’t be said to be accurate measure. Further company can debt to finance bloated working capital, but enterprise value would increase in short run. On the other hand if management works efficiently to reduce working capital thereby increasing cash, they would end up reducing enterprise value in short run.

Focus on short term decisions

Further single minded focus on increasing market value of equity can result into many decisions for short term benefit which can hurt in long run. It would preclude most management to focus on management results instead of building wrong term value.

Focus on Long Term Value Maximisation

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