Shareholder-Value Maximization and Product-Market Competition

This paper investigates product-market competition under the assumption that managers maximize shareholder value. This contrasts with the standard assump-tion in studies of industrial organization that managers maximize their expected discounted value of firm profits. These assumptions are not equivalent when shareholders are imperfectly informed about firm profitability. We demonstrate conditions under which shareholder-value maximization leads to more aggressive product- market strategies than profit maximization. This effect arises because rival firms profits provide information about a firms value: lower profits of ri-vals leads investors to believe that the firm is more valuable. Thus, firms try to reduce their rivals profits in an effort to increase their own stock price. We draw implications of these effects for corporate financial structure.