Transcript OTHER OBJECTIVES OF THE FIRM

ALTERNATIVE
OBJECTIVES OF
THE FIRM
OVERVIEW
• Managerial theories of the firm (non-profit
maximizing objective flowing from separation
between ownership & management)
• There are several models, but mainly concentrating
on:
– Baumol’s constrained sales maximization model
– Marris’ maximization of managerial utility model
• Behavioral theories of the firm (firm looked upon
as a Satisficer rather than a Maximizer)
– Cyert and March
Constrained Sales Maximization
Model (Baumol)
• Managers maximize sales revenue subject
to earning a minimum acceptable level of
profit
– Minimum level of profit determined by need to
be able to raise finance to pay for future sales
expansion
– Managers’ salaries more closely linked to sales
than profits, so managers seek to maximize
sales
– Larger the firm, easier to raise capital at low
rates of interest
– Large sales encourage bandwagon effect and
retains distributors
Constrained Sales Maximization
Model (Baumol)
Extension of Constrained Sales
Maximization Model (Baumol)
• Extension of model
– The firm’s objective is the maximization of long-run sales
revenue
– Firms may use the profits in excess of the required
minimum to influence the demand conditions through
marketing investment and product development.
• Outward shift in demand curve – sales increase for
any given price level
• Assuming that any expenditure on advertising etc.
increases sales, long run sales maximization requires
that all profit in excess of the minimum be deployed
in affecting demand
• Then, long run sales maximization always leads to the
profit constraint being operative
Extension of Constrained Sales
Maximization Model (Baumol)
Sales, Cost, Profit
Which point will be chosen under four ∏ constraints
Total cost
∏4
∏3
Profit curve
∏1
∏2
Sales curve
A:∏-max
B:Sales max
C:∏=0
Q
Maximization of Managerial
Utility Model (Marris)
• Decisions on levels of investment and dividend
payments taken by top level management
• Top management maximizes a utility function with
two arguments: long run sustainable growth of
sales (desire for higher salary, power, and
prestige) and job security (avoiding takeovers)
• Tradeoff between growth and security:
– High growth – higher interest charges from more
borrowing (thus increased costs) and increased proportion
of retained profits (thus lower dividend rates) – leads to
threat of takeover and job loss
– Excessive concern for job security (i.e. preference for
high rate of profit) – minimize reliance on borrowed funds
– slower growth in sales (lower salary, prestige etc.)
Maximization of Managerial
Utility Model (Marris)
Cyert & March’s Behavioral
Theory of the Firm
• Firm’s objective: To achieve satisfactory
values of profits, sales, managerial
benefits, etc. rather than maximum values
of these variables
• Two important characteristics:
– Firm is subject to bounded rationality i.e. its
behavior is intendedly rational but limitedly so
due to informational problems
– The firm attempts to satisfy the
goals/aspirations levels of different interest
groups in terms of these variables