Objectives Of Firms

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Unit 6
Structure
6.1 Introduction Objectives 6.2 Profit Maximization model Self Assessment Question 1 6.3 Economist Theory of firm Self Assessment Questions 2 6.4 Cyert and Marchs behavior theory Self Assessment Questions 3 6.5 Marris growth maximization model Self Assessment Questions 4 6.6 Boumals static and dynamic models Self Assessment Questions 5 6.7 Williamsons managerial discretionary theory Self Assessment Questions 6 6.8 Summary Terminal Questions Answer to SAQs and TQs 6.1.

Objectives Of Firms

Introduction
A business firm is an economic unit. It is a producing unit. It converts inputs in to outputs. It is a legal entity on the basis of ownership and contractual relationship organized for production and sale of goods and services. All business units are set up and managed by people and are called by various names like shops, firms, enterprise, production and business concerns etc. They can take several forms like sole trader, partnership concern, Joint Stock Company, cooperatives or even public utilities. They produce and supply different goods and services for the direct satisfaction of consumers for producing other final goods and services. Each firm lays down its own objectives. They are fundamental to the very existence of a firm. They are the end-point towards rational activity. They indicate the very existence of a firm and guide the
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actions of a firm. They indicate how a firm has to organize its activities and perform its functions. A modem business unit has multiple objectives and they are multi-dimensional in their nature. Some of them are competitive while others are supplementary in nature. A few other objectives are mutually interconnected and a few others are opposing in nature. These objectives are determined by various factors and forces like corporate environment, socio-economic conditions, and the nature of power in the organization and extraneous conditions, and constraints under which a firm operates. Each business unit defines its own objectives which may have to satisfy the needs of those groups whose cooperation makes the continued existence of multiple and diversified objectives. Learning Objectives: After studying this unit, you should be able to understand the following 1. To understand the background under which a firm lays down its multiple objectives. 2. To explain how modern business units instead of having a single objective has several objectives. 3. To analyze how profit-maximization is the basic objective of a firm even today. 4. To describe many objectives like maximizing sales revenue of the firm, maximizing the growth rate of the firm, maximizing the utility functions of managers etc. Economists over a period of time have developed various theories and models to explain different kinds of goals of modern firms. Broadly speaking they can be dived in to three groups. They are as follows1. The profit maximization model. 2. Managerial theories or models 3. Behavioral theories or models. Let us study some of the important theories under each category. 6.2 Profit Maximization Model Profit-making is one of the most traditional, basic and major objectives of a firm. Profit-motive is the driving-force behind all business activities of a company. It is the primary measure of success or failure of a firm in the market. Profit earning capacity indicates the position, performance and status of a firm in the market. It is an acid test of economic ability and performance of an individual firm. There is no place for a firm unless it earns a reasonable amount of profit in the
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the business possible-the share

holders, management, employees, suppliers and consumers etc. Thus, we come across

business. It is

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necessary to stay in business and maintain in tact the wealth producing agents. It is a widely accepted goal and there is nothing bad or immoral about it. Earlier profit maximization was the sole objective of a firm. This assumption has a long history in economic literature and the conventional price theory was based on this very assumption about profit making. In spite of several changes and development of several alternative objectives, profit maximization has remained as one of the single most important objectives of the firm even today. Both small and large firms consistently make an attempt to maximize their profit by adopting novel techniques in business. Specific efforts have been made to maximize output and minimize production and other operating costs. Cot reduction, cost cutting and cost minimization has become the slogan of a modern firm. It helps to predict the price-output behavior of a firm under changing market conditions like tax rates, wages and salaries, bonus, the degree of availability of resources, technology, fashions, tastes and preferences of consumers etc. It is a very simple and unambiguous model. It is the single most ideal model that can explain the normal behavior of a firm. It is often argued that no other alternative hypothesis can explain and predict the behavior of business firms better than profit-maximization hypothesis. This model gives a proper insight in to the working behavior of a firm. There are well developed mathematical models to explain this hypothesis in a systematic and scientific manner. Main propositions of the profit-maximization model. The model is based on the assumption that each firm seeks to maximize its profit given certain technical and market constraints. The following are the main propositions of the model. 1. A firm is a producing unit and as such it converts various inputs into outputs of higher value under a given technique of production. 2. The basic objective of each firm is to earn maximum profit. 3. A firm operates under a given market condition. 4. A firm will select that alternative course of action which helps to maximize consistent profits 5. A firm makes an attempt to change its prices, input and output quantity to maximize its profit. The model Profit-maximization implies earning highest possible amount of profits during a given period of time. A firm has to generate largest amount of profits by building optimum productive capacity both in the short run and long run depending upon various internal and external factors and forces. There should be proper balance between short run and long run objectives. In the short run a firm is able to make only slight or minor adjustments in the production process as well as in business
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conditions. The plant capacity in the short run is fixed and as such, it can increase its production and sales by intensive utilization of existing plants and machineries, having over time work for the existing staff etc. Thus, in the short run, a firm has its own technical and managerial constraints. But in the long run, as there is plenty of time at the disposal of a firm, it can expand and add to the existing capacities, build up new plants, employ additional workers etc to meet the rising demand in the market. Thus, in the long run, a firm will have adequate time and ample opportunity to make all kinds of adjustments and readjustments in production process and in its marketing strategies. It is to be noted with great care that a firm has to maximize its profits after taking in to consideration of various factors in to account. They are as follows1. Pricing and business strategies of rival firms and its impact on the working of the given firm. 2. Aggressive sales promotion policies adopted by rival firms in the market. 3. Without inducing the workers to demand higher wages and salaries leading to rise in operation costs. 4. Without resorting to monopolistic and exploitative practices inviting government controls and takeovers. 5. Maintaining the quality of the product and services to the customers. 6. Taking various kinds of risks and uncertainties in the changing business environment. 7. Adopting a stable business policy. 8. Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them. 9. Maintaining its reputation, name, fame and image in the market. 10. Profit maximization is necessary in both perfect and imperfect markets. In a firm is a price-taker and under imperfect market it becomes a price-searcher. Assumptions of the model The profit maximization model is based on tree important assumptions. follows 1. Profit maximization is the main goal of the firm. 2. Rational behavior on the part of the firm to achieve its goal of profit maximization. 3. The firm is managed by owner-entrepreneur. Determination of profit maximizing price and output Profit maximization of a firm can be explained in two different ways.R Madhavi Asst Professor, MBA

perfect market, a

They are as

a. Total Revenue and Total Cost approach.

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b. Marginal Revenue and Marginal Cost approach. Profits of a firm are estimated by making comparison between total revenue and total costs. Profit is the difference between TR and TC. In other words, excess of revenue over costs is the profits. Profit = TR TC. If TR is equal to TC in that case, there will be break even point. If TR is less than TC, in that case, a firm will be incurring losses. In this case, we take in to account of total cost and total revenue of the firm while measuring profits. It is clear from the following diagram how profit arises when TR is greater than that of TC

N1

TC

Cost I Revenue

TR

N2

Output

2. MR and MC approach In this case, we take in to account of revenue earned from one unit and cost incurred to produce only one unit of output. A firm will be maximizing its profits when MR= MC and MC curve cuts MR curve from below. If MC curve cuts MR curve from above either under perfect market or under imperfect market, no doubt MR equals MC but total output will not be maximized and hence total profits also will not be maximized. Hence, two conditions are necessary for profit maximization1. MR = MC. diagram. 2. MC curve cut MR curve from below. It is clear form the following

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Objectives Of Firms
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MC

P . .

P1 MR

Output

Q1

MC

.N

. N1 MR

Output

Q1

Justification for profit maximization 1. Basic objective of traditional economic theory. The traditional economic theory assumes that a firm is owned and managed by the entrepreneur himself and as such he always aims at maximum return on his capital invested in the business. Hence profit-maximization becomes the natural principle of a firm. 2. A firm is not a charitable institution. A firm is a business unit. It is organized on commercial principles. A firm is not a charitable institution. Hence, it has to earn reasonable amount of profits. 3. To predict most realistic price-output behavior. This model helps to predict usual and general behavior of business firms in the real world as it provides a practical guidance. It also helps in predicting the reasonable behavior of a firm with more accuracy. Thus, it is a very simple, plain, realistic, pragmatic and most useful hypothesis in forecasting price output behavior of a firm.
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4. Necessary for survival It is to be noted that the very existence and survival of a firm depends on its capacity to earn maximum profits. It is a time-honored hypothesis and there is common agreement among businessmen to make highest possible profits both in the short run and long run. 5. To achieve other objectives. In recent years several other objectives have become much more popular and all these objectives have become highly relevant in the context of modern business set up. But it is to be remembered that they can be achieved only when a firm is making maximum profits. Criticisms 1. Ambiguous term. The term profit maximization is ambiguous in nature. There is no clear cut explanation whether a firm has to maximize its net profit, total profit or the rate of profit in a business unit. Again maximum amount of profit cannot be precisely defined in quantitative terms. 2. Always it may not be possible. Profit maximization, no doubt is the basic objective of a firm. But in the context of highly competitive business environment, always it may not be possible for a firm to achieve this objective. Other objectives like sales maximization, market share expansion, market leadership building its own image, name, fame and reputation, spending more time with members of the family, enjoying leisure, developing better and cordial relationship with employees and customers etc. also has assumed greater significance in recent years. 3. Separation of ownership and management. In many cases, to-day we come across the business units are organized on partnership or joint stock company or cooperative basis. In case of many large organizations, ownership and management is clearly separated and they are run and managed by salaried managers who have their own self interests and as such always profit maximization may not become possible. 4. Difficulty in getting relevant information and data. In spite of revolution in the field of information technology, always it may not be possible to get adequate and relevant information to take right decisions in a highly fluctuating business scenario. Hence, profits may not be maximized. 5. Conflict in inter-departmental goals. A firm has several departments and sections headed by experts in their own fields. Each one of them will have its own independent goals and many a times there is possibility of clashes between the interests of different departments and as such always profits may not be maximized.
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6. Changes in business environment. In the context of highly competitive and changing business environment and changes in consumers tastes and requirements, a firm may not be able to cope up with the expectations and adjust its policies and as such profits may not be maximized. 7. Growth of oligopolistic firms. In the context of globalization, growth of oligopoly firms has become so common through mergers, amalgamations and takeovers. Leading firms dominate the market and the small firms have to follow the policies of the leading firms. cases, there are limited chances for making maximum profits. 8. Significance of other managerial gains. Salaried managers have limited freedom in decision making process. Some of them are unable to forecast the right type of changes and meet the market challenges. They are more worried about their salaries, promotions, perquisites, security of jobs, and other types of benefits. They may lack strong motivations to make higher profits as profits would go to the organization. They may be contented with only satisfactory level of profits rather than maximum profits. 9. Emphasis on non-profit goals. Many organizations give more stress on non-profit goals. From the point of view of todays business environment, productivity, efficiency, better management, customer satisfaction, durability of products, higher quality of products and services etc have gained importance to cope with business competition. Hence, emphasis has been shifted from profit maximization to other practical aspects. 10. Aversion to reduction in power. In case of several small business units, the owners do not want to share their powers with many new partners and hence, they try to keep maximum powers in their hands. In such cases, keeping more power becomes more important than profit maximization. 11. Official restrictions over profits of public utilities. Public utilities or public corporations are legally prohibited to make huge profits in many developing countries like India. Thus, it is clear that a firm cannot maximize its profits always. There are many constraints in the background of multiple objectives. Each one of the objectives has its own merits and demerits and a firm has to strike a balance between all kinds of objectives. However, today it is the view of many experts that in spite of several alternative objectives, a firm has to make adequate profits. For undertaking any kind of welfare or other activities to promote the welfare of either consumers or workers, a firm should have sufficient revenue. Other wise all other objectives would remain only on paper and can never be implemented. Non-profit goals serve as supplementary or complementary
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ones to the primary objective of profit maximization Thus, the traditional objective of profit maximization has relevance even today of course with some modifications. Self Assessment Questions I

1. In __
his profits.

_ model, the important assumption is that the entrepreneur aims at maximising is the point where the firm has stopped incurring losses but yet to start gaining profit.

2. _

3. The full form of TR is _

6.3 Economist Theory Of Firm According to Economist theory of firm, a firm is a producing unit. It transforms or converts all kinds of inputs in to outputs. The basic function a firm is to produce those goods and services which are demanded by consumers in the market. It produces various kinds of goods and services and supplies them in the market for the satisfaction of different groups of people either directly or indirectly. A firm is a business unit and it is organized on commercial principles. In the process of production and sale of different goods and services, it aims at making profits. According to this theory, a traditional firm is a group with a particular organizational and management structure having command over its own property rights. It is a legal entity on the basis of ownership and contractual relationship organized for production and sale of goods and services. In olden days a firm was called by various names like shops, firms, enterprise, production and business concerns etc. But today, it is organized on various forms like a sole trader, partnership concern, Joint Stock Company, cooperative society etc. A firm is formed, run and managed by an owner, employer or an entrepreneur who has the following characteristics. 1. He has the legal permission to run an enterprise. 2. He can enter in to contract with any group of people who supply productive resources. 3. He can take his own decisions to maximize his economic gains. 4. He is entitled to enjoy the residual income after making payments to all productive resources in the form of rent, wages and salaries and interest. 5. He can transfer his rights and obligations to other individuals on the basis of contracts.

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6. He can direct and dictate the suppliers of productive resources in the manner he likes of course on the basis of legal contracts. 7. He can change the nature of management according to his convenience. 8. He has all the rights to make changes in his organization which he feels the best. He can consult others or he can take his own final decisions. Thus, a firm is managed by a private person who centralizes all his decisions on the basis of legal contracts and makes enough profits. He has his own personal interests to run the business unit. Such a type of business unit has emerged as a dominant form of business organization over a period of time. It has its won advantages as the firm is managed by an individual. A firm managed by an individual has several advantages over other forms of organization. 1. He can take immediate and quick decisions to maximize his economic gains. 2. Direct control over the firm will ensure higher productivity, efficiency, better supervision, better performance etc. Better control and management helps him to have time-bound programs 3. He can reward factor inputs on the basis of their performance and get best services from them. 4. He adopts a flexible business policy to suit the changing conditions without any of loss of time. Thus, this form of business organization has emerged as the classical entrepreneurial firm and has become most popular over a period of time. The above mentioned features of the classical firm have been described as the theory of firm by various economists. The traditional or classical firm basically engages itself in various kinds of economic activities which help in maximizing its profits. It concentrates on wealth-creation and through it surplus creation. Surplus value is nothing but the difference between the value of the final product and the value of various inputs employed in the production process. Surplus generation is possible when the firm produces maximum output with minimum costs. Hence, a firm works out the most ideal factor combinations to avoid all kinds of wastages, cut down costs and maximize its output. When the firm produces maximum output with minimum costs then it will reach the equilibrium position. This is possible when total revenue is equal to total cost or marginal revenue is equal to marginal cost. At the equilibrium point, it is said that a will be maximizing its profits. The nature of working of a firm depends on several factors like number of firms in the market, size of the firm, volume of production, entry and exit if firms, degree of competition, existence of alternative substitutes, prices of goods etc. Thus, the traditional or classical firm aims at profit maximization and over the years this objective has been replaced by profit optimization.

Self Assessment Questions 2 1. According to Economist Theory Of Firm, a firm is a _ while doing so, tries to create surplus value. 2. The firm aiming for profit maximization reaches its equilibrium only when it produces 3. Business decisions are made to cope with 6.4 Cyert And Marchs Behavior Theory Another alternative non-profit maximizing theory has been developed by Cyert and March. The theory makes an attempt to explain the behavior of inter group conflicts and their multiple objectives in an organization. Basically, this theory explains the usual and normal behavior of different groups of people who work in an organization having mutually opposite goals. Prof, Simon has developed the initial behavioral model and Prof. Cyert and March have further elaborated the theory in their book Behavioral Theory of the Firm published in 1963. Cyert and March explain how complicated decisions are taken in big industrial houses under various kinds of risks and uncertainties in an imperfect market in the background of limited data and information. The organizational structure, goals of different departments, behavioral pattern and internal working of a big and multi - product firm differs from that of small organizations. The various kinds of internal conflicts and problems faced by these organizations would certainly affect the decision- making process of these organizations. They also explain how there are certain common problems faced by similar organizations in an industry and their effects on the internal working of each individual organization and their decision making process. Cyert and March consider that a modern firm is a multi-product, multi-goal and multi-decision making coalition business unit. Like a coalition government, it is managed by a number of groups. The group consists of share holders, managers, workers, customers, suppliers, distributors, financiers, legal experts and so on. Each group is independent by itself and has its own set of objectives and they try to maximize their individual benefits. For example, shareholders expect faster growth of the company and higher dividends, workers expect maximum wages and minimum work, better working conditions, welfare measures, managers want higher salary, greater power, autonomy in day to day working, dominance, control etc, suppliers quick and immediate payments etc. contributions made by each one of the group is equally important in carrying the activities of a firm. In their view out of . unit, which converts input into output and

several groups, the most important ones are the shareholders, workers and managers in an organization. Cyert and March points out the goals of a business organization would depend upon the multiple objectives of each group and their collective demands. The nature of demand depends on the relative strength and importance of each group in an organization, aspiration and expectation level of each group, past success in their demands, relative success of other groups both with in and out side the organization etc. It is quite clear that goals of each one of the group is multiple, conflicting and opposite in their nature. Each one of the group out of their past experience and success, availability of limited resources at the disposal of a firm, would arrange their demand on the basis of priorities. Most urgent demands are highlighted and low-priority demands are postponed to latter periods. The management may honor a few demands of a few groups and postpone the demands of other groups in view of financial constraints. This may create heart-burns and conflict between different groups in the same organization. It is to be remembered that the demands of each group would depend on their aspiration levels, expectations, actual performance of the organization, bargaining power of the each group, past success in their demands, etc. As all of them change over a period of time, the demands of each group would also under go changes. If actual performance and achievements of the organization is much better than expected aspirations and target level, in that case, there will be upward revision in their demands and vice-versa. Thus, there is a strong linkage between the expected and actual demand of each group in the organization, past success and future environment. Each group makes an attempt to achieve its demand in its own way. Through the process of hard bargaining, a winning coalition is formed and the broad objectives are setout by the management. There may be conflict in different objectives of different groups and the management has to overcome them intelligently. Cyert and March suggest the following methods to overcome the conflicts of different groups and smooth working of the organization. They are as follows. Demands of each group may be separated from that of the other and separate attempts are made to fulfill them so that their impact on the whole organization may be avoided. For example, they would grant higher monetary rewards for various factor inputs like higher wages, salaries and bonus to workers, grant of other perquisites to keep them happy. They may also grant side payments to different departments to carryon their work smoothly, For example, more funds may be released to R&D, buying computers & other equipments etc. share holders may be granted higher dividends, managers are given more powers, more

autonomy, higher salaries, lavish and luxurious air-conditioned offices, vehicles, and various kinds of facilities to keep them happy. They are called as slack payments. Certainly, it will have stabilizing effects on the working of an organization as it will build up the morale of the top management. These additional benefits may be flexible to suit to the profit and loss conditions of a firm. Demands of each group may be met over a period of time as and when they arise without jeopardizing the general interest of the organization. The management may follow the policy of sequential attention. On the basis of the priority and importance of each demand, the management may fulfill most urgent demand first and then postpone the remaining less-urgent ones. The management may also tackle the problem by decentralizing the decision making process. It can give more autonomy to each department to work out its program, avoid mutual conflicts, ensure harmony and balance in different goals, and optimize its working. Cyert and March are of the opinion that out of several objectives a firm has five important goals. They are 1. Production goal. Production is to be organized on the basis of demand in the market. Neither there should be over production nor under production but just that much to meet the required demand in the market, avoid excess capacity, over utilization of capital assets, lay-off of workers etc. 2. Inventory goal. Inventory refers to stock of various inputs. In order to ensure continuity in production and supply, certain minimum level of inventory has to be maintained by a firm. Neither there should be surplus stock or shortage of different inputs. Proper balance between demand and supply is to be maintained. 3. Sales goal. There should be adequate sales in any organization to earn reasonable amounts of profits. In order to create demand sales promotion policies may be adopted from time to time. 4. Market-share goal. Each firm has to make consistent effort to increase its market share to compete successfully with other firms and make sufficient profits 5. Profit goal. This is one of the basic objectives of any firm. The very survival and success of the firm would depend upon the volume of profits earned by it. The above mentioned objectives also would under go changes over a period of time in the background of modern business environment. Hence, decision making would become complex and complicated.

It is quite clear that each business organization has its own set of goals. These goals would depend on the ever changing demands of different groups who have their own conflicting objectives. There is need for harmonious and balanced blending of different objectives of an organization and multiple objectives of different groups working in the organization. The final objectives emerge after continuous bargaining between different groups of the coalition. The management has to accommodate as many as possible demands of different groups with out jeopardizing its own basic goal of making profits The model developed by Cyert and March is also similar to that of the model developed by prof. Simon. The model highlights on satisfactory levels of performance and achievements of its multiple objectives as maximization of different goals may not be possible in the context of complex business world. Hence, making satisfactory levels of profits rather than maximum profits has become the order of the day. On the basis of its performance, the goals are set. If the target goals are not achieved, in that case it makes an attempt to search the reasons for its failure and on the basis of experience it revises its goal. Suitable changes are made in its objectives, targets, and strategies to achieve them in a given time frame. If the modified objectives are achieved drastic changes in them become inevitable. The top management takes the decisions in the background of limited time, resources, knowledge, information and data. It is too difficult for them to examine the merits and demerits of all available alternatives and choose the best one among them. They take rational decisions to achieve satisfactory levels of goals. Hence, Cyert and March points out that satisfactory behavior is most rational in nature Demerits. 1. The theory fails to analyze the behavior of the firm but it simply predicts the future expected behavior of different groups. 2. It does not explain equilibrium of the industry as a whole. 3. It fails to analyze the impact of the potential entry of new firms in to the industry and the behavior of the well established firms in the market. 4. It highlights only on short run goals rather than long run objectives of an organization. Thus, there are certain limitations to this theory. Self Assessment Questions 3 1. _ _ is related to demand of sales management and sales decision.

2. _ 3. _ 4. _

_ is related to price and resource allocation decisions. _ works as a shock absorber. _ and _ types of resolving conflicts are qualitative. _ and _ goals

5. Cyert and March points out that the coalition group has multiple, 6.5 Marris Growth Maximization Model

Profit-maximization is a traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of the objectives of a firm. A growth rate is a better yardstick to measure the success of a firm. Growth depends on the volume of investment. Investment depends on capital availability. Capital may come from either internal or external source. External source of capital is costly where as internal generation of funds is economical. Generation of internal capital depends on profit making capacity of a firm. Hence, profit maximization would automatically lead to growth maximization. It is for this reason, Marris points out that a firm has to maximize its balanced growth rate over a period of time. Marris assumes that the ownership and control of the firm is in the hands of two groups of people, ie, owners and managers. He further points out that both of them have two distinctive goals. Managers have a utility function in which the amount of salary, status, position, power, prestige and security of job etc are the most important variables where as in case of owners are more concerned about the size of output, volume of profits, market share and sales maximization etc. Utility function of the managers and that the owners are expressed in the following manner- Uo = f [size of output, market share, volume of profit, capital, public esteem etc] Um = f [salaries, power, status, prestige, job security etc]. In view of Marris the realization of these two functions would depend on the size of the firm. Larger the firm, greater would be the realization of these functions and vice-versa. Size of the firm according to Marris depends on the amount of corporate capital which includes total volume of assets, inventory levels, cash reserves etc. He further points out that the managers always aim at maximizing the rate of growth of the firm rather than growth in absolute size of the firm. Generally managers like to stay in a growing firm. Higher growth rate of the firm satisfy the promotional opportunities of managers and also the share holders as they get more dividends.

Marris identifies two constraints in the rate of growth of a firm.1. There is a limit up to which output of a firm can be increased more economically, limit to manage the firm efficiently, limit to employ highly qualified and experienced managers, limit to research and development and innovation etc. 2. The ambition of job security puts a limit to the growth rate of the firm itself deliberately. If growth reaches the maximum, then there would be no opportunity to expand further and as such the managers may loose their jobs. Rapid growth and financial soundness should go together. Managers hesitate to take unwanted risks and uncertainties in the organization at the cost of their jobs They would like to avoid risky investment projects, concentrate on generating more internal funds and invest more finance on only those products and services which brings more profits Hence, managers would like to seek their job security through adoption of a cautious and prudent financial policy. He further points out that a high risk-loving management would like to maintain a relatively low amount of cash on hand and invest more on business, borrow more external funds and invest more in business expansion and keep a low profit levels. On the other hand, a highly risk-averting management may have exactly opposite policy. Ultimately, it is the job security which puts a constraint on business decisions by the managers. The Marris growth maximization model. highlights on achieving a balanced growth rate of a firm. Maximum growth rate [g] is equal to two important variables1. The rate of demand for the products [gd] 2. 2. Growth rate of capital[gc] Hence, Max g = gd = gc. The growth rate of the firm depends on two factors- a] the rate of diversification [d]and b] the average profit margin. The diversification rate depends on the number of new products introduced per unit of time and the rate of success of new products in the market. The success of new products is determined by its changes in fashion styles, consumption habits, the range of products offered etc. More over diminishing marginal returns would operate in any business and as such there is a limit to diversification. Similarly, market price of the given product, availability of alternative substitute products and their relative prices, expenses and publicity, propaganda and advertisements, R&D

utility and comparative value of the product etc would decide the profit ratio. Higher expenditure on sales promotion and R&D would certainly reduce profits level as there are limits to them. The rate of capital growth is determined by either issue of new shares to obtain additional funds and external funds and generation of more internal surplus. Generally a firm would select the last one to avoid higher degrees of risks in the business. The Marris model states that in order to maximize balanced growth rate or reach equilibrium position, there should be equality between the growth rate in demand for the products and growth rate in supply of capital. This implies the satisfaction of three conditions. 1. The management has to maintain a low liquidity ratio, ie, liquid asset I total assets. But this ratio should not create any financial embarrassment to meet the required payments to all the concerned parties. 2. The management has to maintain a high ratio between a debt I asset so that it will have enough money to invest in order to stimulate growth. 3. The management has to keep a high level of retained profits for further expansion and development but it should not displease the share holder by giving low dividends. In this case, the mangers would maximize their utility function and the owners would maximize their utility functions. The managers are able to get their job security with a high rate of growth of the firm and share holder would become happy as they get higher amount of dividends. Demerits 1. It is doubtful whether both managers and owners would maximize their utility functions simultaneously always 2. The assumption of constant price and production costs are not correct. 3. It is difficult to achieve both growth maximization and profit maximization together. Self Assessment Questions 4 1. According to (owners). 2. In__ _, the objective of the firm is balanced growth. modern firms are managed by both the manager and the shareholders

3. In Marris Growth Maximization Model, the manager tries to maximize his satisfaction and his satisfaction lies in the .

4. In _

_ relationship, growth determines profit.

6.6. Boumals Static And Dynamic Models. Sales maximization model is an alternative model for profit maximization. This model is developed by Prof. W.J.Boumal, an American economist. This alternative goal has assumed greater significance in the context of the growth of Oligopolistic firms. The model highlights that the primary objective of a firm is to maximize its sales rather than profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimum profit constraint. The minimum profit constraint is determined by the expectations of the share holders. This is because no company can displease the share holders. It is to be noted here that maximization of sales does not mean maximization of physical sales but maximization of total sales revenue. Hence, the managers are more interested in maximizing sales rather than profit. The basic philosophy is that when sales are maximized automatically profits of the company would also go up. Hence, attention is diverted to increase the sales of the company in recent years in the context of highly competitive markets. In defense of this model, the following arguments are given. 1. Increase in sales and expansion in its market share is a sign of healthy growth of a normal company. 2. It increases the competitive ability of the firm and enhances its influence in the market. 3. The amount of slack earnings and salaries of the top managers are directly linked to it. 4. It helps in enhancing the prestige and reputation of top management, distribute more dividends to share holders and increase the wages of workers and keep them happy. 5. The financial and other lending institutions always keep a watch on the sales revenues of a firm as it is an indication of financial health of a firm. 6. It helps the managers to pursue a policy of steady performance with satisfactory levels of profits rather than spectacular profit maximization over a period of time. Managers are reluctant to take up those kinds of projects which yield high level of profits having high degree of risks and uncertainties. The risk-averting and avoiding managers prefer to select those projects which ensure steady and satisfactory levels of profits. Prof, Boumal has developed two models. The first is static model and the second one is the dynamic model.

The Static Model This model is based on the following assumptions. 1. The model is applicable to a particular time period and the model does not operate at different periods of time. 2. The firm aims at maximizing its sales revenue subject to a minimum profit constraint. 3. The demand curve of the firm slope downwards from left to right. 4. .The average cost curve of the firm is U-shaped one. With the help of the following diagram, we can explain sales maximization model subject to a minimum profit constraint.
TC Y TC, TR, PROFIT TR M Q

Operative Profit Constraint

P2 P1 R P 0

N K

P2 P1 Non Operative Profit Constraint X Output

P X1 X2 X3

Profit curve

At OX1 level of output profit is maximum, TR is much in excess of TC. If the firm chooses to produce OX3 output profit will fall to X3K though the TR is still in excess of TC. Profit constraint is les at OX2 level of output as the firm earns X2 N profit depending upon the market condition a firm can determine the level of output with minimum profit constraint. Sales maximization [dynamic model] In the real world many changes takes place which affects business decisions of a firm. In order to include such changes, Boumal has developed another dynamic model. This model explains how

changes in advertisement expenditure, a major determinant of demand, would affect the sales revenue of a firm under severe competitions. Assumptions 1. Higher advertisement expenditure would certainly increase sales revenue of a firm. 2. Market price remains constant. 3. Demand and cost curves of the firm are conventional in nature. Generally under competitive conditions, a firm in order to increase its volume of sales and sales revenue would go for aggressive advertisements. This leads to a shift in the. demand curve to the right. Forward shift in demand curve implies increased advertisement expenditure resulting in higher sales and sales revenue. A price cut may increase sales in general. But increase in sales mainly depends on whether the demand for a product is elastic or inelastic. A price reduction policy may increase its sales only when the demand is elastic and if the demand is inelastic; such a policy would have adverse effects on sales. Hence, to promote sales, advertisements become an effective instrument today. It is the experience of most of the firms that with an increase in advertisement expenditure, sales of the company would also go up. A sales maximizer would generally incur higher amounts of advertisement expenditure than a profit maximizer. However, it is to be remembered that amount allotted for sales promotion should bring more than proportionate increase in sales and total profits of a firm. Otherwise, it will have a negative effect on business decisions Thus, by introducing, a non-price variable in to his model, Boumal makes a successful attempt to analyze the behavior of a competitive firm under oligopoly market conditions. Under oligopoly conditions as there are only a few big firms competing with each other either producing similar or differentiated products, would resort to heavy advertisements as an effective means to increase their sales and sales revenue. This appears to be more practical in the present day situations. Self Assessment Questions 5

1. Sales maximization model is an alternative for _

model.

2. Boumal thinks managers are more interested in maximising _ rather than profit. 3. In oligopoly market structure, the firms compete more in terms of advertisement, product
variations etc. rather than _ _.

6.7

Williamsons

Managerial

Discretionary

Theory
Prof. O.Williamson has developed a highly useful and most practical managerial utility model to explain goals of a business firm in recent years. In many organizations we come across that when once a firm achieves a certain amount of growth, the top mangers concentrate their attention on maximizing their self-interest and allow the growth rate to continue. Thus, profit maximization and managers utility maximization go together. Assumptions of the model 1. Existence of imperfect markets. 2. Ownership and management is separated 3. A minimum level of profit is to be achieved by a firm to pay dividends to share holders. The model Williamson is of the opinion that managers as a powerful group in any organization have their own set of utility functions. They have certain expectations and demands. Generally they aim at maximizing their managerial utility functions rather than maximizing total profits of the company. They feel that a firm is making profit on account of the efforts of top management and as such they are entitled to certain special privileges and eligible to enjoy special benefits. The various kinds of managerial satisfaction includes the degree of freedom and autonomy given to them, their status, prestige, power enjoyed by them, dominance, professional excellence, security of their jobs, salary and other perquisites etc. Out of these variables, only salary is measurable and all other variables are non-measurable. to In order to measure This concept helps other variables, Williamson introduces the concept of expense preference.

measure the level of satisfaction which managers would derive from certain types of

expenditures. The managers utility function is expressed as U = f [S, M, Id] Where S = Additional expenditure of staff. M = Managerial Emoluments Id = Discretionary investment. The staff expenditure [S] includes the wages and salaries paid to additional staff employed who have to work under the top management. Now managers will have a larger team than before and allot the work to new staff as a firm expands. The mangers now enjoy more powers to control their subordinates. Higher wages or salaries are paid in accordance with their productive ability and professional excellence which certainly would motivate the workers to work more.

Managerial emoluments [ M] include expenses on entertainment, luxurious air-conditioned office, Costly company cars and other allowances, given to managers. It has been pointed out that these expenses are justified by managers as it would enhance their status, prestige, power, better working environment and image of the company in the eyes of public etc. This would motivate the managers to do their work in a congenial atmosphere and free manner. Discretionary power of investment expenditure {Id] includes those investment expenses which confer certain personal benefits and satisfaction to managers. For example, expenditure on latest equipments, furniture, decoration materials etc. These expenses are expected to elevate the status and esteem of managers. They satisfy their ego and sense of pride. Thus, all these expenditures are made by a firm to keep the managers happy and motivate them to work more. The above mentioned expenditures are measurable in terms of money and they can be used as proxy variables to replace the non-operational concepts like power, status, prestige, professional excellence etc appearing in the managerial utility function. It is to be noted that all the expenses are included in total cost of operations of a firm. The profits of the company are measured by taking tin to account of total expenses and total revenue earned by a firm. The difference between the TR and TC would measure the volume of profits. A minimum amount of profits are required to distribute reasonable dividends to share holders. Otherwise, they demand for a change in management. This would create job insecurity to the managers. Hence they can maximize their utility functions only when they ensure reasonable profits to a company. There is no direct relationship between managers utility function and better performance always. The empirical evidence is not enough for the verification of the theory. Always a firm cannot spend more money on only improvements in the working conditions of mangers. It has to look in to the interests of all groups in an organization. Self Assessment Questions 6

1. The expenditure, which is incurred by the Managers indulgence in a company car is termed by
Williamson as _ and D stands for .

2. In the equation u = f (S , D ) , S stands for

6.8. Summary Units 6 enlighten us about the various alternative objectives of a firm. The traditional objective is that of profit maximization. But in recent years, economists have developed various alternative objectives to suit to modern business environment. The theory of firm highlights on wealth-maximization or creation of maximum assets through which it can generate economic surpluses. The profit maximization theory stresses on earning maximum amount of profits by a firm. Cyert and March theory concentrates on the behavior of various coalition partners in an organization and explain how opposite goals of different groups would affect the decision making of a firm. Marris model analyses the rate of growth of a firm via maximizing managers powers and status. Boumal analyses the impact of advertisement expenditures incurred by a firm on sales promotion and its impact on total sales revenue of a firm. Williamson studies the impact of managerial utility functions on the performance of a firm. Thus, a firm has several alternative goals and the selection of particular goals depends on the management of a firm. It is to be remembered that all other objectives of a firm can be realized only when a firm is making reasonable amount of profits. Any organization has to earn adequate profits to please the shareholders. In order to make more profits, a firm has to create more wealth, assets, and surpluses, satisfy the expectations of top managers, workers, and achieve a high growth rate of the firm. All objectives are inter connected and supplement one another. Realization of one objective would depend on other objectives. Hence, there should be a proper balance between different objectives. Terminal Questions

1. Discuss profit maximising model. 2. Explain economist theory of firms. 3. Analyse Syert to Marchs behavious theory 4. Examine the Marris growth maximising model. 5. Critically examine Boumals static and dynamic models. 6. Give an account of William sons managerial discretionary theory.

Answer to Self Assessment Questions Self Assessment Questions I

1. Profit Maximisation Model 2. Break Even point 3. Total Revenue

Self Assessment Questions 2 1. Transformation

2. Profit maximizing output 3. Changes

Self Assessment Questions 3

1. Market share goal 2. Profit goal 3. Slack payment 4. Sequential hearing to demand and Decentralizing the decision making 5. Conflicting and opposite
Self Assessment Questions 4

1. Robin Marris 2. Marris Growth Maximization Model 3. Growth rate of the firm 4. Differentiated diversification
Self Assessment Questions 5

1. Profit maximization 2. Sales 3. Price

Self Assessment Questions 6 1. Management slack 2. Staff expenditure and discretionary profit Answer to Terminal Questions 1. Refer to Unit 6.2 2. Refer to Unit 6.3 3. Refer to Unit 6.4 4. Refer to Unit 6.5 5. Refer to Unit 6.6 6. Refer to Unit 6.7