January 26, 2022

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Shareholders Wealth Maximization (SWM)

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One and the most important goal of a financial manager is that of shareholders’ wealth maximization (SWM). However, it is not just an individual goal. It is a collective goal for all members of the board of directors of a company.

Shareholders’ wealth maximization arose as a need to provide better benefits to shareholders as profits are not the best criteria for an indication of the benefit derived by the owners because of its bounded limitations.

What is Shareholders Wealth Maximization (SWM)

Shareholders’ wealth maximization is the increase in the total market capitalization of a company.

It can also be seen as an increase in capital gains for the shareholders.

SWM is the increase in the net current value of the business.

For example, if the market price per share for a company is 55 Naira in 2015. An increase to 70 Naira in 2019 means that the wealth of each shareholder for that company has soared.

Another way to look at it is based on the market capitalization of a quoted company. A growth in it means an added value to SWM.

Example of SWM using Access Bank Market Data from NSE

Access bank market price per share and market capitalization are a good example of this.

For the market price per share, using available stock data from the Nigerian Stock Exchange, the market price per share on February 6th, 2020 was 9.75 Naira per share. The price increases on Fen 7th and 13th to 9.80 Naira per share. Such share price rise is an increase in shareholders’ wealth maximization.

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Financial manager goal: Shareholders Wealth Maximization (SWM)

How to calculate Shareholders Wealth Maximization

Use of Share Price. An increase in market price per share is an indicator that the value of shareholders has increased. Unlike dividend whose reward is within a year and the shareholder may make use of the cash within that year. An increase in share price adds value to the shareholder. Dangote is a good example of this. Aliko Dangote remains the richest man in Africa. Why? Is wealth from shares increased over time because of the market price per share of Dangote cement and its subsidiary surges? If price/share increase more it increases Dangote’s wealth.

To calculate the SWM based on share price, multiply the current price per share by the number of shares of the individual shareholder.

Use of Market Capitalization.

This is the widely used method for shareholders’ wealth maximization. Similar to share prices, an increase in Market Cap, increases SWM. To calculate this, multiply the current market price/share by the number of outstanding shares available for sale at the stock exchange market.

Present Value of Projects

This is the most acceptable way of calculating shareholders’ wealth maximization. This method makes use of cash flow. The cash flow is discounted to mitigate inflation and other factors. The result is the present value of shareholders’ wealth.

Shareholders’ wealth is maximized when the present value (NPV) is higher than the cost of investment. Or a positive NPV. For example, If the present value for a project is 10.34 billion Naira and the cost of that investment is 8 billion Naira, then, the NPV of the project is 2.34 billion which is a positive NPV. In such a case, it is said that the wealth of shareholders is maximized.

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Another way to look at it is the summation of all positive NPV of various projects. If a firm has three projects it is undertaking. Assuming all the projects resulted in positive NPVs. Then the additive value, NPV1 + NPV2 + NPV3 becomes the SWM.

A third aspect is based on short and long term bases. If there are alternative projects to choose from, say project A and project B, the project with the shortest period is said to be the one that maximizes shareholders’ wealth irrespective of the value of the Net Present Value. What this means is that, if project A NPV is higher than project B NPV. But project B is for a short time say five years and project A is 10 years. The finance manager will prefer to undertake the project B. A reason for this is risk and uncertainty. It is not clear what will happen in ten years’ time. To avoid such uncertainty, project B is taken thereby maximizing shareholders’ value.

Factors affecting shareholders wealth maximization

There are various factors affecting SWM. Three of such are discourse below.

Market information

The information and news reports affect SWM. This is also referred to as the efficient market hypothesis. If quality information is heard from the company, the share price goes up as more investors will be willing to buy its shares. For example, the increase in the profit after tax for a company for the current year will trigger investors to buy more of its shares thereby increasing the value of the share and the result is increased in SWM.

The willingness of the Investor to Invest

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Also, the willingness to invest in shares affects SWM. If investors are not willing and able to buy shares of a company, the value of the shares will remain stable or diminished. However, if the readiness value goes up.

Agency theory

This affects the board of directors. Here, the board is an agent to its principal, who are the shareholders. However, the board needs to be committed to other issues. Such as job security, employee satisfaction, customers, suppliers, and government require certain obligations from them. Achieving all of these along with maximizing shareholders wealth becomes a big issue.

For example, tax liability affects profit for a firm. An increase in corporation tax by the government will reduce the profit after tax earned by the company. The resultant effect is that SWM may be affected.

What Next

So far, you have read about shareholders’ wealth maximization. You learn its meaning, calculations, and factors influencing it. Next, Economic Wealth Maximization will be considered. its

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