Question

Profit maximization is a standard assumption in several economics textbooks and is presented as the ultimate goal of the firm. In finance, however, you will see, time after time, that the ultimate goal of the manager is to maximize the stock price.

One may think that they imply the same so that if a company is a profit maximizer, this company's stock price will automatically be maximized. Alternatively, one might believe that one is superior to the other.

Please discuss if “profit maximization” implies “stock price maximization” and they may be used interchangeably or they are quite different concepts and one is superior to the other. You may use your textbook, as well as other web sources to build your point.

Answer 1

Profit maximization Differs from stock price maximization. Under the profit maximization goal, the managers only function upon increasing their profits at any cost. For this purpose the management undertakes many risky projects which will increase their profits but which increase the risk of the organization leading to a decline in the stock prices. This is not the right approach since it leads to an overall decline in the value of the firm. The management should have wealth maximization as the ultimate goal. This enables the management to pick the current projects which will increase the wealth of the stockholders and lead to an increase in the share price.