OpenQ : 6
Why is profit maximization not the right objective for corporate finance?
Summary: Profit is one year’s accounting number. It ignores when cash arrives, how much risk a firm takes to earn it and who outside the firm pays. This piece explains why corporate finance replaced it with value, and where value fails too.
In the first four months of 2026, companies in the S&P 500 spent a record $665 billion buying back their own shares. A buyback does not raise a company’s profit by one dollar, but it raises profit per share, because the same profit is divided among fewer shares. That is the first clue to why corporate finance does not tell managers to maximize profit. Profit is a number an accountant reports for one year, and a manager can move it without making the firm worth more.
The first problem is time. Profit adds up what a firm earns in a year and treats this year’s dollar the same as a dollar five years from now. A manager who wants a higher profit this year can cut research, delay maintenance or stop training staff. Each cut raises the year’s profit and takes money from the firm’s future. Corporate finance discounts future cash because a dollar today can be invested and a dollar in five years cannot.
The second problem is risk. Profit says nothing about the chance of losing. A bank that lends to weak borrowers at high rates reports higher profit until the loans go bad. A firm that borrows heavily can earn more for its owners in a good year and fail in a bad one. Two firms with the same profit can carry very different risks, and their owners should not value them the same.
The third problem is cash. Profit rests on choices about when to count a sale and how fast to write down a machine. A firm can report a profit and run out of cash, because profit is not money in the bank.
So the textbooks, from Brealey, Myers and Allen to Aswath Damodaran, set a different goal: maximize the value of the firm to its owners. Value is today’s worth of all the cash the firm will earn, adjusted for when it arrives and how risky it is. A manager who cuts research to lift this year’s profit lowers value, because the market counts the lost future.
Value has its own failures. Boeing spent about $43 billion buying back shares from 2013 to 2019 while it rushed the 737 MAX into service, and two crashes killed 346 people. A congressional investigation in 2020 found that pressure to meet schedules and cut costs ran through the program. Markets can reward the short run, and value counts only the cash that reaches owners. It leaves out the river a factory pollutes and the town a closed plant empties. In 2017 the economists Oliver Hart and Luigi Zingales argued that firms should maximize the welfare of their shareholders, not their market value, because shareholders care about more than money.
The OpenQ
Corporate finance has an answer to profit: value. It does not have an agreed answer to value. In 2019 the Business Roundtable, which speaks for the heads of America’s largest companies, said firms serve customers, workers, suppliers and communities as well as shareholders, while buybacks kept climbing. The open question is whether any goal other than shareholder value can be measured well enough for a board to be held to it.
Think About
A firm that dumps waste in a river earns more for its owners than one that pays to clean it. If the law allows it, has the first firm done its job better?
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