ALTERNATIVE OBJECTIVES OF THE FIRM

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ALTERNATIVE OBJECTIVES OF THE FIRM
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OVERVIEW

• Managerial theories of the firm (non-profit
  maximizing objective flowing from separation
  between ownership management)
• There are several models, but mainly
  concentrating on
• Baumols 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

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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

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Constrained Sales Maximization Model (Baumol)
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Extension of Constrained Sales Maximization Model
(Baumol)

• Extension of model
• The firms 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

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Extension of Constrained Sales Maximization Model
(Baumol)

• Sales, Cost, Profit

Which point will be chosen under four ?
constraints?
Total cost
?4
?3
?2
?1
Profit curve
Sales curve
BSales max
A?-max
C?0
Q
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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.)

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Maximization of Managerial Utility Model (Marris)
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Cyert Marchs Behavioral Theory of the Firm

• Firms 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