An Improved Pedagogy of Corporate Finance: A Constrained Shareholder Wealth Maximization Goal

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ABSTRACT

The most prominent textbooks in finance literature present the goal of a firm or financial manager as "unconstrained shareholder wealth maximization (USWM) " and focus on economic efficiency and maximization of shareholder wealth, providing limited information about potential constraints. In contrast, constrained shareholder wealth maximization (CSWM) requires students to put equal emphasis on both the objective function (maximizing shareholder wealth) and the constraint (keeping natural stakeholders protected). Our survey of finance textbooks reveals an inadequate level of introduction to these topics, possibly misleading students to believe that society should define its laws in favor of firms (shareholders) at the expense of natural stakeholders. Thus, misinformed students might see stakeholder wealth expropriation as fair game in its extreme form due to our outdated finance pedagogy. In attaining the teaching goal of CSWM as an improved pedagogy, we offer specific suggestions to finance textbook authors.

INTRODUCTION

Bloom's taxonomy (1956) has guided pedagogical structure and innovation for half a century in the United States, and its focus on developmental learning remains relevant and instructive for us. The six developmental levels (knowledge, understanding, application, analysis, synthesis, and evaluation) separate basic knowledge acquisition from the critical thinking and analytical skills necessary for making ethical decisions or judgments. Answering questions about business ethics requires knowledge from multiple disciplines, including philosophy, psychology, political science, sociology, economics, finance, organizational management, and law. Analyzing such a vast body of data in ethical frameworks requires the highest levels (analysis, synthesis, and evaluation) of critical thinking as expressed in the taxonomy. Corporate governance, an interdisciplinary subject addressed in all these disciplines, explores the inter- workings of both for-profit firms and not-forprofit firms and is an area requiring business students to evaluate ethical issues when making decisions.

Despite the broad responsibility of teaching corporate governance in the finance classroom, the pedagogy of finance has been restricted to ideas derived primarily from economics, statistics, and finance. Competing ideas from other disciplines are generally unwelcome and/or are treated with skepticism. Even the ideas of some researchers from the fields of economics and finance such as Hart (1995) and Tirole (2001) who promote alternate solutions to corporate governance beyond agency theory are ignored or overlooked. As a result, business ethics and corporate governance topics often are introduced in apro forma, compulsory fashion that may satisfy the requirements of a business school curriculum, but appear without commitment to their supporting philosophies. Even in schools whose mission should be consonant with alternative economic perspectives (such as the tenets of Catholic social teaching in Catholic institutions), students typically are given little or no exposure to unconventional governance perspectives.

Current finance textbooks do not provide enough information about the constraints of shareholder wealth maximization (SWM), competing corporate governance theories, and business ethics. Finance students are expected to address ethical issues in their careers without having been introduced to the lowest level (analysis) of critical thinking in their schooling years.

Our survey of fourteen frequently -used textbooks in the corporate finance field reveals that almost every textbook uniformly teaches or emphasizes the goal of the firm as unconstrained shareholder wealth maximization, but offers inadequate discussion of competing corporate governance theories and business ethics. The authors of these commonly-used finance textbooks argue that the goal of profit maximization is flawed due to its susceptibility to misuse and manipulation. …