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The Disadvantages of Stock Price Maximization & Profit Maximization

Original post by Michael Wolfe of Demand Media

Sometimes, a business will decide that its goal is to boost its own share price as high as it can possible go. While it is a worthy goal for a business to decide that it wishes to reward its shareholders by increasing the value of their investment, there are serious problems when a company confuses building an organization that can maximize profits in the long term and one that reaps short term gains at great long-term cost.

Stock Price Maximization

There are a number of ways that a company can maximize its share price -- that is, appear most attractive to investors, thereby inflating its value. Some of these involve creative accounting, such as counting certain revenues as profits when they may in fact reflect other kinds of revenues, while others may involve presenting a particular face to the market. In all cases, the moves are made with the intention of impressing investors, not improving the company.

Misleading

Perhaps the biggest problem with consciously attempting to boost a share price is that it is misleading to investors. Some companies will see their share price climb due to skillful leadership and an objective evaluation of the company's worth by the market as a whole. However, if a company makes only cosmetic changes in an effort to increase its value, its investors will likely eventually see a steep correction.

Short-Term Gains

In an effort to boost its stock price, many companies will attempt to record short-term gains. These gains can come from many sources, including one-time receipts of income rather than the development of new revenue streams that will bear fruit in the long run. The downside to championing short-term gains over long-term gains is that the investors may well not receive significant profits in the long term, again causing a correction of share price.

Overpayment

One of the reasons that leaders choose to value the rise in a company's stock price over its actual health is that it is paid to -- through an incentive package that pegs the leader's payment to stock price, not to other kinds of gain. When a person leading a company is paid this way, not only is the company not headed in a solid direction, but it may be badly overpaying him for the caliber of work he is doing.

                   

References

  • "Investing For Dummies"; Eric Tyson; 2008
  • "Economics"; Roger A. Arnold; 2008

About the Author

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.

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