Value maximization and the Corporate Objective Function

  • Jensen M
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Abstract

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. I argue that since it is logically impossible to maximize in more than one dimension, purposeful behavior requires a single valued objective function. Two hundred years of work in economics and finance implies that in the absence of externalities (and when all goods are priced) social welfare is maximized when each firm in an economy maximizes its total market value. Total value is not just the value of the equity but also includes the market values of all other financial claims including debt, preferred stock, and warrants. Stakeholder theory, argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm (including not only financial claimants, but also employees, customers, communities, governmental officials, and under some interpretations the environment, terrorists, blackmailers, and thieves). Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no way to keep score, stakeholder theory makes managers unaccountable for their actions. Yet stakeholder theory is widely accepted by managers and directors. It seems clear that such a theory can be attractive to the self interest of managers and directors. It takes more than acceptance of value maximization as the organizational objective to create value. As a statement of corporate purpose or vision value maximization is not likely to tap into the energy and enthusiasm of employees and managers to create value. Since a firm cannot maximize value if it ignores the interest of it's stakeholders enlightened value maximization can utilize much of the structure of stakeholder theory by accepting long run maximization of the value of the firm as the criterion for making the requisite tradeoffs among its stakeholders.

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APA

Jensen, M. C. (2000). Value maximization and the Corporate Objective Function. Harvard Business School, 12(2), 235–256.

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