Chapter 2 • A framework for financial decision making
Maximisation of profit
Profit here would normally be interpreted as accounting profit, which is discussed at
some length in Chapter 3. This objective arises from the fact that the shareholders are
the owners of the business and, as such, both the exercisers of ultimate control and the
beneficiaries of profits. It is therefore argued that the shareholders will cause man-
agers to pursue policies that would be expected to result in the maximum possible
profit. This analysis is acceptable up to a point, but maximising profit could easily be
sub-optimal to the shareholders. It may be possible to increase profit by expanding the
business’s scale of operations. If the increase merely results from the raising of addi-
tional external finance, it might mean that profit per share could actually decrease,
leaving the shareholders worse off.
Pharmaceutical products manufacturers typically spend vast amounts of money on
developing and testing new products. It is in the nature of the industry that the time
taken to bring a new drug to the market can easily be ten years. A particular business
that stopped spending money on research and development would enhance current
profit because costs would be cut but revenues arising from continuing to sell drugs
developed in past years would continue for the time being. Thus current profits would
be buoyant but the business would face a bleak future since there would be no new
drugs to replace the old ones.
It is probably open to most businesses to increase their profits without additional
investment if they are prepared to take additional risks. For example, cost cutting on
the control of the quality of the business’s output could lead to increased profits, at
least in the short term. In the longer term, placing substandard products on the mar-
ket could lead to the loss of future sales and profits.
Clearly, increasing profitability through greater efficiency is a desirable goal from
the shareholders’ point of view. However, maximisation of profit is far too broad a
definition of what is likely to be beneficial to shareholders.Maximisation of the return on capital employed
This objective is probably an improvement on profit maximisation since it relates
profit to the size of the business. However, as with profit maximisation, no account is
taken of risk and long-term stability.Survival
Undoubtedly most businesses would see survival as a necessary, but insufficient,
objective to pursue. Investors would be unlikely to be attracted to become shareholders
in a business that had no other long-term ambition than merely to survive. In times
of economic recession and other hardship, many businesses will see survival as their
short-term objective, but in the longer term they would almost certainly set their sights
somewhat higher.Long-term stability
This is similar to survival and is similarly unrealistic in its lack of ambition as a long-
term target.