Chapter 2 • A framework for financial decision making
viewed with enthusiasm by the investing public. This in turn would be expected to
lead to a low share price. Conversely, a satisfied workforce is likely to be perceived
favourably by investors. It is reasonable to believe that a broadly similar conclusion
will be reached if other members of the coalition are considered in the same light.
Maximisation of shareholders’ wealth may not be a perfect summary of the typical
business’s financial objective. It does, however, provide a reasonable working basis for
financial decision making. What must be true is that businesses cannot continually
make decisions that reduce their shareholders’ wealth since this would imply that the
worth of the business would constantly be diminishing. Each business has only a finite
amount of wealth, so sooner or later it would be forced out of business by the results
of such decisions.
Jensen (2001) makes the point that it is impractical to expect managers to pursue
more than one goal. This is partly because it is difficult to know how to strike the
balance between the interests of the various members of the coalition that make up
the business. Jensen also argues that trying to pursue more than one goal makes it
impossible for managers to make purposeful decisions. Without a way to assess their
success, managers in effect become less accountable. Whatever may be said against
maximisation of shareholders’ wealth as the business objective, it has the great merit
that management’s achievement is relatively easily assessed, certainly for businesses
whose shares are traded in an open market, where their value can be observed.11.9 Evidence on gearing
Survey evidence
Several studies have been conducted in the UK, most of which have involved ques-
tioning senior managers of large businesses by interview or postal questionnaire.
Pike and Ooi (1988) conducted a postal questionnaire at two points in time, 1980 and- The 1980 questionnaire was sent to 208 large UK businesses. The 1986 question-
naire was sent to the businesses that had responded in 1980, provided that they had
not disappeared as a result of amalgamations, takeovers and the like. In both surveys,
the usable response rate exceeded 70 per cent. In both 1980 and 1986, senior finance
executives were asked to indicate on a five-point scale the importance to their busi-
nesses of five financial objectives, two of which were short-term and three long-term.
The mean rankings for the objectives were as shown in Table 2.1. Note that a
ranking of 5 implies that the objective is very important and a ranking of 1 implies
an unimportant objective.
Table 2.1The importance of financial objectives (1980–86)Objective 1980 1986Short-term (1 to 3 years):
Profitability (e.g. percentage rate of return on investment ) 4.28 4.61
Profits or earnings (i.e. a profit target) 4.01 4.41
Long-term (over 3 years):
Growth in sales 3.18 2.97
Growth in earnings per share 2.83 4.38
Growth in shareholders’ wealth 3.07 4.06Source: Adapted from Pike and Ooi (1988)