Maximize Shareholder Wealth or Self-Utility?

Standard textbooks prescribe shareholder wealth maximization as the main goal of financial management. Yet, mangers are known to give themselves huge pay packages, often at the expense of shareholder wealth. This behavior is traditionally known as "agency" cost in the business literature. Agency costs exist due to only partial observability of managers' actions by the shareholders, and loopholes in the legal infrastructure. The traditional solution to this problem is to give managers bonuses and options to align their interests with the interests of the shareholders.

However, any human behavior not recognized and accepted, only creates higher order perversions. Free human beings living in free markets must rationally maximize their own self-utility. Maximizing shareholder wealth cannot be an absolute rule, but a constrained maximization, which should be subordinate to maximizing one's own self-utility. For example, if two choices both give self-utility of 100 units each, but the first choice makes shareholders richer, then the managers take that choice. Of course, due to unobservability of the managers actions by shareholders, often managers will and do maximize their own utility, at the expense of shareholder's wealth.

The ex-ante knowledge that shareholders have the right to fire or sue managers, generally keeps the managers behaving in line consistent with shareholder objectives. But its almost tautological that managers always maximize their own self-utility, even when they increase shareholder profits with some self-imposed constraints or objectives (arising due to self-integrity or greed). For example, for some managers the constraint of not hurting a worker is not a serious issue (encouraged by the draconian anti-labor laws in some states, which impose only a small monetary fine for killing a worker even with an intentional safety violation), while for other managers, not hurting another goes beyond their "small-self" fiduciary duty to shareholders, to serve their "big-self" human responsibility.

Modern capitalism sprang from the twin forces of innovation and exploitation, both feeding and reinforcing each other. These forces framed the laws of many western nations. So for example, if one knows as a manager that some labor practice causes serious arm injuries, but keeping that labor practice maximizes shareholder value even after paying for all monetary expenses for the arm injuries, then it becomes one's fiduciary duty to maximize shareholder value.

But what is legal is not necessarily what is ethical. Ethics relate to one's SELF-DEFINTION, while law is defined with respect to the system. Ethics are a function of one's individual utility function, while law is created by the dominant forces that come to rule the govt agencies. If one lives under the tyranny of Saddam, then what is ethical may be very distant from what is legal. Similarly, just because Blacks or women or men without property were not allowed to vote legally in 18th century did not make that ethical in USA. So if our rich, racist, but intelligent founding fathers designed labor laws that basically hurt the workers (small monetary fines in some states even for killing workers with intentional safety violations that maximize profits), and we continue to practice those laws, then we may end up hurting the workers to serve our fiduciary duty, but our ethical human Self may revolt at that idea.

If our human Self is much bigger than our identity as a manager at a company in a system designed to hurt the workers (e.g., meat-packing industry), or the customers (e.g., pharmaceutical industry), or the environment, it is very desirable for us to question our fiduciary duty and behave in accordance with our larger human responsibility. If we are willing to take the chance of getting sued by the shareholders or fired by the shareholders, we can see it as very ethical to try and stop practices that are known to hurt the workers, or the customers, or the environment.

Of course, if we abuse our power and spend company money on installing the most expensive diamond studded carpets in our offices, then we will most likely get fired. But since we know that that outcome is a possibility, we will most likely not engage in such actions using our utility function. But we still use our own utility functions to make such decisions and not the shareholders' utility function. Our utility functions calculate, ex-ante, the possibilities of getting fired or sued or whatever, depending on the actions we undertake.

So in conclusion, we may very often see it as our BIG-SELF HUMAN responsibility to serve the exploited workers, naive customers, and the environment, and not solely focus on maximizing shareholder wealth, by taking the chance that we may get fired or sued. Of course, we do what we can to increase shareholder wealth to the extent it does not compromise with our self-integrity. No one can force one to maximize someone else's utility. One may feel "self-richer" in not compromising with one's integrity, than someone else who may be a millionaire but may injure or kill a couple of workers every other year.