Profit maximising, is it Law or just mythical?

Created a topic to discuss whether there is an legal obligation for a business to maximise profits or whether that is a myth.

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One paper on the matter but there are many available that reiterate that the basic tenet is to maximise shareholders financial interests over all other considerations. If there is a legal means to circumvent any Act then businesses and Boards are obliged to take those actions to maximise the profits for shareholders benefit.

Deakin Law Review

Corporations law in Australia provides no provisions for social welfare but determinately adopts Berle’s shareholder primacy norm. Corcoran notes that corporations law is essentially founded on the principles of the Companies Act 1862 (UK). She states, “It is a laissez-faire statute which promotes a strict rule of profit maximisation. It actively discourages corporate concern for social welfare when social welfare must be purchased at a cost to profit maximisation, even when the social welfare is that of its own employees.”[14] The primary statutory directors’ duties are found in sections 180, 181, 182 and 183 of the Corporations Act 2001 (Cth). These duties are: to use due care and diligence,[15] act in good faith,[16] not make improper use of position[17] and not make improper use of information.[18] In addition to statutory duties, common law imposes the duty to use skill, care and diligence, and the duty to act bona fide in the best interests of the company as a whole.

Directors enjoy broad authority to conduct the management of a corporation, yet are required to exercise their powers in a manner which the directors honestly believe to be in the best interests of the company. Given that the fiduciary duty is owed to the company, any actions which foster profitability appear to be in the company’s best interests. As a result, the traditional legal position provides that the role of a corporation is to maximise profits. In undertaking the obligation to maximise profits a director has broad discretion. The subjective nature of the Australian position is best outlined by Lord Greene in Re Smith & Fawcett. [19] He states, “Directors must exercise their discretion bona fide in what they consider – not what a court may consider – is in the best interests of the company, and not for any collateral purpose.”[20] Only in extreme circumstances, for example where a company has ceased to carry on business, or where there is absolutely no conceivable benefit, will it be possible to convince the court that directors did not honestly believe their actions were in the best interests of the company. Pennycuick J in Charterbridge Corp Ltd v Lloyds Bank Ltd [21] provides a degree of objectivity in the test despite the prima facie subjective base. His test asks, “…whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.”[22]

Directors are required to believe that their actions will maximise the company’s profits in the short or long term. Langton and Trotman note the difficulties associated with such a vague time period. They state, “…exactly how long remains unspecified. For that reason it is submitted that the phrase ‘best interests of the company’ should be equated in Australia with ruthless profit maximisation over some unspecified period.”[23] As a result, strict interpretation of the law suggests that Australian directors must give exclusive consideration to advancing the financial, not social or moral interests of shareholders.

Even the Senate Standing Committee on Legal and Constitutional Affairs on this matter accedes that the duty is to maximise the financial interests of the shareholders, this may even mean that short term gains are put aside to provide long terms profits, such as you point out paying debts or reinvesting in the company.

There has been enough legal debate and Court cases to affirm that the moral and social interests of the shareholders are overridden by the financial interests of the shareholders. I agree and it appears our legislators agree, that there should be a moral and ethical decision base, and that is why there have been a number of Inquiries in to this matter. It remains a problem though because of the legal casework that already exists. This is particularly why new legislation has been required when businesses act in manners contrary to what we see as the public interest.

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Hi,
Lies, damned lies and greed!
A couple of years ago, I went to the trouble of checking the Corporations Act and I couldn’t find anywhere that maximising return to shareholders was a compelling force. It did say that good governance and, in common parlance, being good are the duties of the members of boards.

or

While the laws do no pin that down as many believe, it is a factual mandate for public companies because:

  • if a company underperforms ‘the [share[ market’ will often cause it to be taken over by a competitor or worse a corporate raider for a bargain price, that will do whatever is required to ‘maximise the value’ prior to on-selling it for a usually tidy profit. Employees typically pay the price through job loss including newly implemented outsourcing that minimally reduces their income if not also their conditions, as do communities by loss of factories, shops, or whatever the mainstay of the business is.
  • if a company underperforms the executive floor will probably not achieve its financial KPIs and all or most of those sitting in it will sacrifice bonus dollars.

Whether a law is required to enforce this is factually important but technically irrelevant per the discussion and general belief about ‘maximising shareholder value’. In practice it is a necessity for business, executive, and board survival.

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Good morning Phil,
So the reason the backs are closing all their country branches is to prevent a take over by a competitor or a corporate raider for a bargain price?
Me thinks not.
And this action caused employees’ job loss and loss to communities, shops, etc.

I stand firm that the misuse of shareholder returns as permission to abuse all other obligations, is due to greed. as you state “all or most of those sitting in it will sacrifice bonus dollars” which are often excessive.

Note: The financial KPIs are set by the company (largely the board) and so are self perpetuating, once maximising income is given absolute power becoming a tyrant not a leader. .

Case Law Hutton v West Cork Railway Co in which it was found that spending Company funds that are for non-shareholders benefit was not legal. In the case the Company was being wound up and a gratuity payment was to be made to the workers to help them after their employment ceased. A shareholder opposed the gratuity payment. The plaintiff won the case on the basis that the company would not be benefiting from the payment. Many would see the payment as being ethical, the Courts held it was an incorrect use of the funds.

While this case was in the UK, its law is applied here as we have benefited (some may say we have suffered) from UK case law in the defining of our laws here.

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Case Law in regards to Section 181 does say

In the case of Australian Securities and Investments Commission v Maxwell Brereton J emphasised that section 181 is not concerned with the conduct of a director in relation to creditors, other persons dealing with or concerned with the company, or anybody else but the company itself ; and that a breach of the obligation to act bona fide in the interests of the company involves a consciousness that what is being done is not in the interests of the company , and deliberate conduct in disregard of that knowledge at [107–110].

So a director is only to concern themselves with the “interests of the company” and in no relation to “other persons dealing with or concerned with the company or anybody else but the company itself. They must act lawfully, often what is lawful in regards to Directors needs to be tested in Court and they do have a large number of defences to call upon.

The Corporation Act is to be dealt with on the basis of Case Law definitions and Common Law Case Law. Some of the good governance regarding directors duties is explained in the linked paper.

There are many papers and explanations that can be cited, including those from ASIC and others that clearly outline that the duty is to maximise profits for the Company (Shareholders in Toto) with almost no regard to moral or social responsibility.

Only new Acts/Laws can change what is in place. The duopoly and duopsony we currently seem to face needs legislation to create a different outcome.

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If the goal is to maximize profits to shareholders, then clearly both companies in the duopoly are failing and the directors should be held to account.

The Colesworths franked dividend yields are both below 4%.

Which just shows that there is no ‘price gouging’ going on at all. Just reasonably well run businesses making reasonable but not outlandish net profits.

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Maximising profits may also include increasing the capital value that is held for shareholders, profit taking does not necessarily all end up as dividends paid. It is simplistic to define the value of the Company purely by what dividend may be paid at any given period. Value may also be seen in the share price a holder may see on the Stock Exchange. There is no reason that short term profit returns to be more heavily weighted than the long term profitability of a business. In fact the long term profit may be a preferred outcome in any given financial year.

Gotcha. So maximizing profits is not the primary driver of the business management. It is the sound running of the business for both short and long term value for the owners and investors as the goal.
If maximizing profit was a matter of law, and it certainly isn’t, then anything a business did to reduce profit would be in breach of this non-existant law. Writedowns on assets, banned. Pay rises, banned. Donating money or sponsoring, banned. Putting money into discretionary spending that would offset cash flow in and therefore effect net profit, banned.

Yes it is about maximising profits, but you conflate what is profit taking with a share dividend. It isn’t solely a share dividend in any given year.

Businesses would prefer not to see pay rises, legislation instead provides for it (plenty of history around why we need legislation to ensure “fair wages”). Not always do the quantum of pay rises happen to the expectation of either side of that argument. Write downs of assets are a tool to often reduce taxes and so keep more equity and money in the business.

Profit maximising is a matter of Law which has been pointed out many times, Case Law has been provided. Don’t like the interpretation of the Law by Courts, then you need to take it up with the legislators and the Courts.

Hasn’t been pointed out even once so far in this topic. Yet to see this mythical section of the laws governing business conduct in Australia.

I have always maintained that the primary responsibility of Directors is to maximise the return on investment for the stakeholders ( while ethically trading and in compliance with the law), and that expenditure that cannot be shown to benefit shareholders is challengeable.

This can throw up some interesting grounds at looking at such activities by companies of donating shareholder funds to campaigns such as The Voice Referendum, Political Donations and some sponsorships where a tangible financial benefit cannot be shown for the shareholders. In Fact many of the activities people expect of Businesses under ESG participation could well fall foul of the requirement, should shareholders choose to make an issue of it.

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