Final answer:
Maximizing shareholder wealth is essential because it reflects the added value to a firm's assets and rewards the shareholders, who own the company and whose investments are at risk. Shareholders vote for a board of directors to manage the company. The choice between borrowing and issuing stock for expansion depends on several financial and strategic factors.
Step-by-step explanation:
Why is it important for the financial manager to maximize shareholder wealth? The primary reason is that the shareholders are the owners of the company and it is their wealth that is at risk. As the caretakers of the shareholders' investment, financial managers have a responsibility to make decisions that increase the value of the ownership of the firm. When shareholder wealth is maximized, it indicates that the firm has added value to its assets, directly benefiting its owners.
Shareholders who own a public company select the company managers indirectly. They vote for a board of directors based on the number of shares they hold. This board is responsible for hiring top executives to run the firm on a day-to-day basis. As a company becomes more established, its financial data becomes more available and transparent, making it easier for external investors like bondholders and shareholders to supply financial capital.
If you owned a small firm requiring a surge of financial capital for a major expansion, your decision to raise funds through borrowing or by issuing stock would depend on various factors. Borrowing does not dilute ownership but does incur debt, while issuing stock dilutes ownership but does not increase debt. The choice largely depends on the firm's current financial situation, the cost of each option, and the willingness to share future profits and control with additional shareholders.