Richard Murphy http://ow.ly/1fhNvz correctly points out that company directors have no explicit legal requirement to maximize profits. He implies that because of this company directors have no obligation or duty to do so and presumably should be concentrating on other objectives. I do not agree.
There are several problems with this argument. The first question to ask is what will happen to a company that elects not to maximize profits. All things being equal, a publicly-traded company that doesn’t maximize profits and competes with one that does will be at a long-term disadvantage. Company profits are used for debt-reduction, capital investment, acquisitions, dividends or share repurchases. Companies make unwise decisions all the time – ill-advised share buy-backs, foolish acquisitions and so on, but intelligent use of company profits has a beneficial impact on a company or on its share price. Companies with a strong stream of income available for these purposes will have better operations, stronger balance sheets, more robust stock market performance and are likely to survive longer.
The second problem is that the terminology is a bit slippery. Profit maximization is not so easy to define. Well-run firms try to maximize profitability over the long-term. Actions to maximize income in the short-term will probably be very different. Often these will not have the same long-term effect, and may be detrimental over time.
Profitability itself is also hard to pin down. Two companies may have the same level of operating profit but different gross margins and different cost structures. Companies that have higher gross margins than their competitors may use additional cash to invest in more research and development, expansion of their sales forces and better IT systems, all of which increase their competitive advantage, but aren’t reflected in this year’s profit. They also have the flexibility to turn this higher margin into increased operating profits at any time by reducing their cost structure to that of their competitors. They can also react to competition by reducing prices.
Finally, I think you have to consider how companies actually work. In any enterprise there is only a certain amount of revenue coming in. Managers main responsibility is to make decisions as to how this should be allocated between competing demands. What is left over becomes operating profit. Maximizing profit is often about reducing the other demands on revenue. Much of this effort aims at reducing the consumption of raw materials, increasing productivity, reducing energy consumption and the like. All these activities are generally economically beneficial and increase the odds that the company will be around in the future.
An effort to maximizing profits seems to me to be essential for the survival of an economic enterprise. Almost all microeconomists would agree.
There are exceptions to the profit-maximizing behavior: some companies do seem to thrive while appearing unconcerned about their operating income. Some may be monopolists whose profitability is closely scrutinized by a statutory body. Some may be privately-held companies with limited capital investment needs and no great worries about their stock price or their cost of capital. They can afford to take a relaxed view. Sometimes private owners have no great need for dividend income beyond a certain level. Even then, you have to ask what are the alternatives that are being pursued. Maybe the company is maintaining extremely low pricing that effectively keeps new entrants out of the market. They may have high wages that ensure fervent staff loyalty, or they may have extensive charitable programs that promote a strong public image. All of these things may translate into increased profitability in the long-term. You cannot necessarily conclude that these companies are not profit-maximizing.
While I agree that while there may be no explicit requirement on company directors to maximize profits, this is at least in part because it would be impossible to define that term usefully. That doesn’t mean that maximizing profit is not a duty, the main duty, of a director and essential to the survival of a company. People who run companies and who explicitly pursue a different course are likely to find themselves with a lot of free time on their hands. In the long-term, of course.
