SHOULD CORPORATE MANAGERS MAXIMIZE FIRM SIZE OR SHAREHOLDER WEALTH - A THEORY OF AN OPTIMAL TRADE-OFF

A firm's shareholders will often turn down positive-net present value projects when there are risky senior claims on the firm's cash flows such as deferred worker compensation or unsecured debt. This paper shows that efficient investment decisions will nonetheless be made if the firm's managers properly balance the demands of shareholders against the well-known propensity to seek excessive growth of their firms. The theory implies that top management compensation should place increasing weight on size and decreasing weight on shareholder wealth, with the firm's increasing long-term obligations to workers, bondholders, and suppliers. (C) 1994 Academic Press, Inc.