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 Total cost Profit curve C:∏=0 B:Sales max A:∏-max ∏1∏1 Sales curve ∏2∏2 ∏3∏3 ∏4∏4 Q Which point will be chosen under four ∏ constraints?

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