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I've been trying to access the papers that state that kind of problem, but most of them need payment for access and I am on a student budget.

I know that maximizing profits=maximizing stock value in a world of certainty, but why is that maximizing stock value will be different from maximizing expected profits in a world of uncertainty?

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If you're a student, then you can typically access papers at your library. It's not quite clear to me what you're asking. You might find this informative: papers.ssrn.com/sol3/papers.cfm?abstract_id=146148 – John May 13 '14 at 14:24
It is microeconomics question. I'm not sure, but the whole thing started with a seminal paper of Peter Diamond in 1967 (which I cannot access for now). – John Doe May 13 '14 at 15:15
This one (found simply by googling Peter Diamond 1967)? ibe.eller.arizona.edu/docs/2008/Segal/… – John May 13 '14 at 16:21
No, it is "The role of a stock market in a general equilibrium model with technological uncertainty" (1967). Hal Varian, in his "Intermediate Microeconomics: A Modern Approach", 8th edition, makes the comment that (I'm not quoting the exact words), in a world of uncertainty, it is difficult to assign a meaning for maximizing profits, but maximizing stock market value (which is the same as maximizing profits in a world of certainty) still has a meaning. – John Doe May 13 '14 at 19:55
I don't have access to that paper. I suggest you get a copy of it from your library. If you have any questions, your professor is likely to be able to provide better answers on this type of question than this site will. – John May 13 '14 at 20:46

In a world of uncertainty no one knows what future profits will be (especially > 1 year from now). All we can do is estimate. Who should we ask? The company management has an incentive to give out estimates that may be too optimistic. If you ask the competitors they are probably too pessimistic. Fortunately we have a machine called the stock market which objectively estimates the present value of future profits to determine the stock price. This estimate is not driven by any one party, but is the result of a consensus in a competitive market with many informed players. So it should be a good estimate. Then all the management has to do is maximize the stock price.

BTW this view did not originate with Peter Diamond, but with the earlier work of Arrow and Debreu. Diamond extended it.

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Can you point me the original article in which Arrow and Debreu showed this distinction between (under uncertainty maximizing profits and stock value? – John Doe Aug 7 '15 at 17:52
I don't think I have ever read the original, but it was an article in French, called "Le role des valeurs boursieres pour la repartition la meilleure des risques", Econometrie, 1953. An English version later appeared later as The Role of Securities in the Optimal Allocation of Risk Bearing, Review of Economic Studies, 31, 1964, pp91-96 – Alex C Aug 7 '15 at 23:49

I agree with Alex C. Profit is too slippery a measure to work with. Focusing on profit raises a number of questions.

  1. Can the reported profit be trusted? Profit as a measure is much more open to manipulation than stock price.

  2. What year’s profits should be maximised? You can see straightaway that a good business decision may result in lower profits for the year while a bad one may actually increase profits for that year. Profit measures some selected short-term period. Stock value attempts a more comprehensive view by examining the short-term (the capitalised value of earnings if the company doesn’t invest) plus the long-term (the present value of growth opportunities if it does invest).

  3. Is the company using the cash optimally? A company may reduce dividends and invest the funds in a project that increases future years’ profits. That looks good. But the shareholder should be asking: if I had received this cash as dividends, could I have earned a return greater than the company is now earning from its new project?



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