Name : Koushik Roy

Session : 2017-2019 July , Semester : 1st

Registration No. : 2373 of 2013-2014 , Roll No. : 3017070025

University : The University Of Burdwan Directorate Of Distance Education

Subject : MBA 103. Managerial Economics(ME)

Topic= “FIVE COMPANY ORGANIZATIONAL GOALS

APPLY BY BOUSMAL’S MODEL,MARRIS MODEL,

WILLIAMSON,S MODEL”
MANAGERIAL THEORIES
BAUMOL THEORY
• According to Baumol, sales revenue maximization is the most
important goal of managers.

MARRIS MODEL OF MANAGERIAL ECONOMICS

• Aim – firm’s aim at balanced rate of growth (G)
• This can be achieved by maximization of rate of growth of demand
for the product of firm (GD) and the rate of growth of capital supply
(GS)
• To achieve the above growth management faces two types of
constraint on its growth-
 Managerial Constraint
 Financial constraint
Goal of the firm

Demand of the members of the coalition

Factors such as aspirations of the members, past achievements,

their expectations, the achievements of other groups in same or
other firms, the information available to them

• The demand of the different groups are competing for the given
resources of the firm, and there is a continuous conflict
• The relationship between demand (aspirations ) and the past
achievements depends on the performance of the firm and the
changes in the environment
 Steady situation – aspirations tend to be equal to past
achievements.
 Dynamic situation – aspirations lag behind achievements
excess profit / surpluses.
Recession situation - aspirations are larger than past achievements
• The five main goal set by the firm are –
  Production goal
 Inventory goal respective dept.
 Market share goal
 Profit goal top management

WILLIAMSON MODEL
• Managers have discretion in pursuing policies which maximise
their utility rather than that of owner shareholder.
• Profit acts as a constraint to this exercise.
• The utility function includes one measurable variable namely,
salary and other non-measurable ones like security, power, status,
prestige, professional excellence.
• To formalize the model, one has to take proxy variables to these
non-measurable ones.
• These proxy variables taken are emoluments of managers or slack
in the form of luxury offices, company car, etc. or the expenditure
which are incurred at the discretion of the managers. This reflect
their power, status, prestige, professional excellence.
• These remunerations have their own advantage (comparison to
salaries), as the person getting these will get tax benefits.
• Such payments catch less attention from the shareholders and
labour force.
Also, status & power of managers is associated with the discretion they
have in undertaking investment. Discretionary investment expenditure
gives satisfaction to manager because it allows them to materialize their
personal favorite projects
The model can be written as follows:
Um ~f (s,m,i).
s = staff expenditure, including managerial salary.
m = managerial remunerations (slack).
i = discretionary investment.
The aim is to maximize the value of Um.

Focus On Profit Maximisation Models For Firms

n both perfectly competitive market and the one that can influence price, profit-maximising output
make decision for any firm, which because profit is difference between (total) revenue and (total)
cost, to find out the firm's profit-maximising output level means analysing its revenue. Suppose
that the firm's output is q, and revenue is R. This revenue is equal to the price of the product P
times the number of units sold: R = P*q. The cost of production C also depends on the level of
output. The firm's profit is •°, thus (Robert & Daniel, 2005):
•°(q) = R (q) - C (q)
To maximise profit, the firm selects the output for which the difference between revenue and cost
is the greatest. This principle is illustrated in figure below.
(Robert & Daniel, 2005)
Objectives of Firm
Firms have two kinds of objective: maximising goals and non-maximising goals. The marginal
analysis is particularly important for maximising goals. However, the marginal analysis cannot
find out how firms maximise profits or revenue. It simply show that what the output and price
must be if they do succeed in maximising these items, whether by luck or by judgment (Alan &
Stuart, 2007, p47).

Maximising goals
Profit maximisation
The traditional theory of the firm assumes that firms aim simply to maximise profit, the
assumption is from two directions:
First, owners are in control of the day-to-day management of the firm.
Second, the main desire of owners is for higher profit (Alan & Stuart, 2007, p47).
Both of these assumptions are questionable, for example: some of very large firms such as Shell,
M&S and Ford are run by managers. There may be thousands of shareholders of each firm, but
each shareholder will typically own only a few shares, which means that the typical owner has
little or no power (Brain & Robin, 1998).
Profit is maximised where marginal revenue (MR) equal to marginal cost (MC), i.e. where the
revenue raised from selling an extra unit is equal to the cost of producing that extra unit. To
assume that it is the owners who control the firm neglects the fact that the dominant form of
industrial organisation is the public limited company, which is usually run by managers rather
than by owners. This may lead to conflict between the owners (shareholders) and the managers,
which because the ways of managers reach to their goals are differ from the owners. This conflict
is referred to as a type of principle-agent problem and emerges when the shareholders
(principles) contract a second party, the managers (agents), to perform some tasks on their
benefit. This has led to a number of managerial theories of firm behavior, such as sales revenue
maximisation and growth maximisation (Alan & Stuart, 2007, p48).

Sales revenue maximisation

On a day-to-day basis most firms likely seek goals rather than profit maximisation. In terms of
Sales Maximisation: many firms make decisions designed to increase or maximise production
and the amount of output sold. More sales means more revenue, but not necessarily more profit.
Henry and William (2007) pointed out that William J. Baumol is a polyhistor who has
contributions to the field of industrial organisation. Baumol (1958) explored the implications of
sales revenue maximisation as an objective function, different from that which is usually
assumed (profit or value maximisation, depending on whether one works with a static or a
dynamic model) for firms in imperfectly competitive markets. Analysis of the strategic implications
of such alternative objective functions, sales maximisation has become a standard element in the
analysis of imperfect competition. Baumol also takes the view that economics is indicating what a
firm's objective function ought to be, it analyze the implications of alternative objective functions
for firm and/or market performance (Henry and William, 2007).
Baumol (1959) has suggested that the manager-controlled firm is likely to have sales revenue
maximisation as its main goal rather than the profit maximisation favoured by shareholders. His
argument is that the salaries of top management are more closely correlated with sales revenue
than profits (Alan & Stuart, 2007, p48).

Baumol's Sales Revenue Maximising Model

In Baumol's Sales Revenue Maximising Model, managers' rewards are more linked to quantity of
sales than to profit, thus firms aim to maximise sales revenue, but subject to a profit constraint.
In figure the firm will choose to produce level of output A, giving total revenue B and profit C. This
implies a higher level of output, and therefore a lower price, than the equivalent profit-maximiser,
who would produce output D and earn revenue E (Howard & Lam, 2001).

Williamson's Managerial Utility Maximising

Model
Williamson's (1963) managerial theory of the firm is similar to Baumol's maximising sales
revenue as a major firm objective. However, Williamson's is more broadly, managers seeking to
increase satisfaction through the greater expenditure on both staff levels and higher sales
revenue. Capital can come from profits, external finance and sales revenue. In Williamson's
opinion, increased sales revenue is the easiest means of providing additional funds, since higher
profits have in part to be distributed to shareholders, and new finance requires greater
accountability. Baumol and Williamson are describing the same phenomenon, but in different
terms.
If management seeks to maximise sales revenues without any thought to profit at all (pure sales
revenue maximisation) then this would lead to output unit is neither raising nor lowing total
revenue, i.e. its marginal revenue is zero (Alan & Stuart, 2007, p48).
Manager's utility is constrained by the relationship between profits and staff expenditure. Up to
the level of maximum profit, staff expenditures and discretionary profits expand together, but if
output continues to increase, profits decline as staff expenditures increase (Kenneth & Caroline
& E.L, 1992).

Constrained sales revenue maximisation

Both Baumol and Williamson pointed that shareholders can exercise some constraint on
managers. Maximum sales revenue is usually occur well than the level of output of maximum
profits. The shareholders may demand at least a certain level of distributed profit, so that sales
revenue can only be maximised subject to this constraint.

Marris's Model of Growth maximisation

The opinion that goals of owners (profit) have been in conflict with the goals of management
(sales revenue) has been assumed. However, Marris (1964) believes that owners and managers
have a common goal - maximum growth of the firm.
Marris (1964) supports that the growth is the primary goal that both managers and owners have.
Managers seeking a growth in demand for the firm's products or services to raise power or
status, while owners seeking a growth in the capital value of the firm to increase personal wealth.
The 'retention ratio', which is the ratio of retained to distribute most of the profits created by
Marris. If managers distributed most of the profit (low retention ration), then the retained profit
can be used for investment, stimulating the growth of the firm. In this case shareholders may be
less content, and the share price lower, thus increasing the risk of a takeover bid (Alan & Stuart,
2007, p49).
The major objective of the firm that both managers and shareholders are in accord is then seen
by Marris as maximizing the rate of growth of the firm's demand and the firm's capital (balanced
growth), subject to an acceptable retention ratio.
Profit maximisation is usually based on the assumption that firms are owner-controlled, whereas
sales and growth maximisation usually assume that there is a separation between ownership and
control. (Alan & Stuart, 2007, p51)

International Journal Of Applied Institutional Governance

Introduction
The aim of this paper is to review the theoretical and quantitative literature which underpins the
Theory of the Firm and alternative theories of firm behaviour.
In the first part of the study classical, managerial and behavioural theories of the firm are discussed
and evaluated from a theoretical perspective.
The second part of the study comprises a review and a critique of the quantitative research
undertaken in this area. Through the combination of the theoretical literature and the research
literature, an attempt is made to evaluate the validity of each theory.
Profit Maximization
Economists have been interested in the objectives of firms, and individuals who control firms, for
centuries. The original theory developed was a profit maximization theory which is attributed to
Marshall (1897, 1890). In profit maximization theory marginal differentiation is used as the method
for measuring the point where this maximum level of profits is attained. The use of marginal analysis
in economics can be traced back to Cournot (1838).
The assumption was made that firms, or owners of firms, would set the marginal cost (MC) of
production, i.e. the cost of the last unit of production, to equal the marginal revenue (MR), i.e. the
revenue received from selling that last unit of production. Mathematically this gives a maximum
amount of profit, if profit is defined as total revenue minus total costs (over a given period of time).
The focus of this analysis was not on the characteristics of individual firms, instead Marshall focused
on general characteristics of the average firm thus developing the idea of the “representative firm”.
Important contributions have been made by Chamberlain: monopolistic competition (1933),
Robinson: monopolistic competition (1933) and Coase: Transaction costs (1937). The central focus of
all these theories is profit maximization. The firms act as “black boxes” and are influenced by simple
supply side variables (MC) and simple demand side variables (MR).
If the classical theory of the firm is accepted then the main objective for owners/ managers of firms is
profit maximization.

Managerial Theories of Firm Behaviour

During the mid 20th centaury it became common-place in the modern world for companies to be
owned by a large number of individual (and institutional) shareholders. The Joint Stock Company was
(and still is) the normal method for business ownership of large-scale firms. This type of ownership
introduces a problem that is not relevant to owner-managed firms, namely separation of ownership
from control or principals from agents. Under this type of business structure the owners
(shareholders) are not the decision makers. Instead, professional managers (agents) are employed to
make business decisions on behalf of the shareholders, who as a collective body have the right to
replace the management but are not otherwise involved in the management of the firm. Why should
the managers of the firms have the same objectives as the owners of the firm? For what reasons
would a manager put profits before other objectives; what might these other objectives be?

Baumol (1959) developed the “Revenue Maximization Hypothesis”. This theory stated that after a
minimum amount of profits have been reached firms that operate in an oligopolistic market will aim
for sales revenue maximization and not profit maximization. This means that the firm will produce
beyond the profit maximizing level of output. This can be tested by looking at the number of firms
which have a minimum profit constraint.

Baumol suggested that firms are more interested in sales for various reasons. Falling sales may make
it difficult to raise finance and may offer a negative impression of the firm to potential buyers and
distributors. Executive pay is often linked more closely to sales than to profits. Baumol was not
suggesting that firms attempted to maximize sales because it may lead to greater market share and
profits in the long run. In this model sales maximization was the ultimate objective.

The most apparent weakness of the model is that it does not address the period of time over which
sales are to be maximized. It is possible that the managers of the firms in question may have wanted
to maximize their short run sales, to gain marketshare in order to maximize their long run profits.
This behaviour is not consistent with the model in question as Baumol stated that sales were the
ultimate objective. The managers were not maximizing sales because of some other benefits that are
linked to increased sales; a maximum level of sales was the aim. If mangers are interested in sales
maximization it is likely to be because of the benefits that they gain from increased sales (power,
salary, and prestige). If this is the case, as it is in model developed by Williamson (1964) then
maximizing sales is not the ultimate objective, the objective is to gain salary, power etc. Sales
maximizing is then a means of achieving your objectives and not an objective in its own right.

Bamoul (1959) developed his model to include advertising and his model predicts that a sales
revenue maximizing firm will advertise, no less than, and most likely more than, a profit maximizing
firm – as additional money spent on advertising will lead to more sales – the only constraint is one of
minimum profit. Bamoul makes no attempt to test this assumption empirically and offers no support
for the validity of the hypothesis.

The managerial discretion model was based on the separation of ownership from control. Williamson
(1964) hypothesised that managers of joint stock firms would have a different set of objectives from
that of profit maximizing. The model started out as a marginal model, with both the price and output
being determined in the traditional profit maximizing method (MR=MC). Williamson then developed
the idea that managers will gain utility from discretionary expenditure on perks such as additional
staff, special projects and other spending that increases costs without increasing profit.

The model was developed from a profit maximizing frame; price and output were determined by the
intersection of the marginal revenue and marginal costs curves. Total costs increase as the mangers
waste money, therefore, the profits left to be paid, as dividends to shareholders, are less than they
would be under profit maximization.

The managerial discretion model was a development of the classical model, and shares many of the
same traits. The model developed by Williamson is a mathematical equation that seeks to explain
managerial behaviour.

The managerial discretion model, like profit maximization, fails if it is taken to literally tell how
businesses set price and output, but it may still be valid at the level of managers’/businesses’
objectives.

Marris (1964) developed the theory of managerial capitalism. In this model the mangers of joint
stock companies are concerned with maximizing the rate of growth of sales, subject to a share
price/capital worth constraint. If the share price falls too low as a portion of the capital worth of the
firm, then the firm may be subject to a take-over bid.

The model states that a managerially controlled firm will opt for a higher rate of sales growth than
an owner controlled firm, and that profits (profit rate) to the owners (shareholders) will be lower in a
managerially controlled firm than it would be for an owner controlled firm, as profit will be retained
to fund growth (new market development, product development etc). The model looks at the trade
off between managers’ desire for a high rate of sales growth, that can offer them the opportunity to
maximise their own utility (in a similar manor to Williamson’s model), and the need to offer
dividends to shareholders. If managers do not offer a high enough dividend then they might lose
their employment. Managers are assumed to (be trying to) maximize the utility function U=U (Ċ, v),
where Ċ and v represented, respectively, the satisfactions associated with power, prestige and salary
and the security from take-over, plus stock–market approval. Ambiguity of the definition of Ċ and v
represent the most apparent limitation of this model, it is difficult to test theories mathematically if
the two main variables have not been clearly identified.

The models developed by Willaimson (1964) and Mariss (1964) both attempt to explain managerial
behaviour with a mathematical equation. By using these models the researchers are trying to move
away from the abstract simplification of the classical theory and construct a more realistic framework
for analysing firm behaviour. But once some of the relevant factors are included then why not
include all relevant factors? The end products are models that offer some intuitive insight into how
separation of ownership form control may affect the objectives of a firm.

Behavioural Theories of the firm

Behavioural theories of the firm were developed by various authors at the start of the second half of
the last century. Simon, (1963) developed a model in which firms consist of a number of decision
makers, many of whom will have different objectives. Individuals within an organisation may be
interested in profits, sales, market share, inventory and production. Organisations are involved in
resolution of conflicts (due to different goals), uncertainty avoidance, problematic search and
organisational learning. Simon (1959), Cyert and March (1963) developed similar models based on
the interaction of individual manages within an organisation. The outcome of these models was that
firms would aim for a satisfactory level of profits and pursue other objectives at the same time.

Malcup points out that the majority of important decisions in terms of profit maximization are not
that complex. Therefore, there is no need to consider the complexities of the firm’s hierarchy or how
information flows throught the hierarchical structure.

“Why should it take special theories of bureaucracy to explain how the news of a wage increase
“flows” through various hierarchical levels up or down or across? Yet this, and this alone, is the
information that is essentially involved in the theory of prices and allocation, since it is the adjustment
to such changes in conditions for which the postulate of maximizing behaviour is employed.” (Malcup
1947;152)

Profit Maximization (Quantitative Studies)

There have been a number of quantitative studies: Hall and Hitch (1939), Liester (1946), Skinner
(1970), Shipley (1981), Jobber and Hooley (1987) and Hornby (1994), which have attempted to
provide evidence in support of, or to detract from, the economic theories that have been developed
to explain business behaviour.

The first study to refute profit maximization as a general rule of firm behaviour was undertaken by
Hall and Hitch (1939). The authors surveyed 38 businessmen to determine what method they used to
set prices and make their output decisions. Hall and Hitch found no support for the profit
maximization theory; the majority of respondents did not use or understand terms such as marginal
revenue, marginal costs, etc. Where the businessmen did understand these terms they found them
of little or no importance.

Hall and Hitch (1939) stand alone as the only researchers to attempt to falsify profit maximization
under all circumstances. A number of theories have been developed to replace profit maximization.
They are generally concerned with ownership and control, the principal agent problem, and not
profit maximization under all circumstances. The (Hall and Hitch, 1939) research was carried out with
ownercontrolled firms and therefore there was no principal agent relationship; thier attack was on
profit maximization as a general theory of firm behaviour.
Managerial Theories of the Firm (Quantitative studies)

Hornby (1994) tested a number of hypotheses, with the aim of finding support for managerial
theories of the firm. The first hypothesis tested was “There will be a negative relationship between
the incidence of profit maximization and size” ( Hornby, 1994; p20) This is due to the likelihood that
as firms increase in size it is expected that there is an increasing division between ownership and
control, therefore larger firms are more likely to be controlled by managers and are unlikely to aim
for a maximum level of profits (according to the managerial theories).

Hornby found no support for this hypothesis. The second hypothesis to be tested, directly compared
owner-controlled firms to managerially controlled firms, again there was no statisically significant
relationship between the ownership of the firm and the business objectives followed.

A final hypothesis was constructed to gain insight into the likelyhood of firms operating with a
minimum profit constraint. Baumol’s (1959) model specifically claims that managerially controlled
firms will operate with a minimum profit constraint, and it was implicit in most other “alternative
theories of firm behaviour”. Hornby (1994) found that owner-controlled firms were significantly
more likely to have a minimum profit constraint than managerially controlled firms. The managerial
theories of the firm predict the exact opposite relationship to the one found by Hornby. Hornby
found no support for any managerial theory of firm behaviour.

References

Baumol,w,J. (1959) Business Behaviour, Value and Growth, Macmillan, London. And

Marris,R.(1964) The Economic Theory of Managerial Capitalism, Macmillan, London.

Williamson,O.E.(1964) The Economics of Discretionary Behaviour, Prentice-Hall, New York

Module: 27 Organizational Goals-III: Managerial Theories of the firm

1. LEARNING OUTCOMES

After completing this module the students will be able to:

 Know and understand Willamson’s Managerial Theory.
 Know and understand Baumol’s Managerial Theory of Sales Maximisation .
 Know and understand Kafolgis Managerial Theory of Output Maximisation.
 Understand the differences between various managerial theories.

2. INTRODUCTION

The theories emerged in the field of economics over time slowly went away from the
assumption of profit maximization. Managerial theories visualized that the firms don’t only aim at
maximizing the profits, rather there are certain other considerations which the firms want to
maximize. These managerial theories and models considered that the business firms are large in size
and ownership is separated from management.
 The owners are the people who are shareholders of the organisation and take risks. The
managers are the people who are hired to manage the affairs of the organisation. Besides Marris,
many other economists suggested various managerial theories, which focused on the organisational
goals other than profit maximization. Williamson stressed on the Utility Maximization goal, while
Baumol focused on Sales/Revenue Maximization for managers.

3. WILLIAMSON’S MANAGERIAL THEORY OF FIRM

The theory proposed by O.E. Williamson is popularly known as ‘Williamson’s Utility Maximization
Theory’ or ‘Managerial Discretion Theory’.
Williamson also stood against the notion of profit maximization as organisational goal and he
favoured the goal of ‘Utility Maximization’. This model of maximizing utility can be applied in the
corporate form of business organisations, where there is divorce between ownership and
management. Williamson added that in the modern times, organisations operate at large scales and
the people who manage the organisations are not the owners of organisation. Thus managers and
shareholders are two different groups, so their goals also differ. The shareholders aim at maximizing
the returns on their investments, while managers aim at some considerations which enhance their
utility function other than profit maximization. Thus shareholders survive with the objective of profit
maximization, while the managers are concerned not only with their own profits, but also with the
size of the organisational staff, the amount of expenditure required for them, taxes to be paid to
government and many other considerations.
Williamson further emphasized that managers are motivated by two motivators: their self interest
and maximization of their own utility function. Thus he added a new dimension of utility
maximization in the previously propounded managerial theories. To a large extent, utility
maximization of a manager depends upon availability of after tax profits. If the after tax profits are
sufficient enough to pay acceptable dividends to shareholders and to sufficiently invest in required
investments (except the discretionary investments by the managers), the managers’ utility
maximization objective can be achieved.
3.1 Managerial Utility function
Williamson explained that the managers aim to maximize their utility function, which is further
dependent upon staff, its expenditure and many other considerations. To the extent the pressure
from capital market and competition in the product market is imperfect, managers has the discretion
to pursue the goals other than profit maximization.

4. BAUMOL’S SALES MAXIMIZATION THEORY

A theory which had taken sales maximization as organisational goal was propounded by Prof.
William Baumol. This theory is also known as Revenue Maximisation Theory. Baumol propounded
this theory based on his own experience of American oligopoly firms. He explained this managerial
theory of the firm, as the firms go after sales maximization objective in the long run. As in the
modern times, the ownership and management of the firms have been separated, the managers aim
at maximizing their sales revenue, as it attracts more salaries and prestige for them even at the
expense of large profits. In the organisations managers measure the growth in terms of their sales.
Thus sales or revenue maximization rather than profit maximization is the actual goal of the firms.
According to Baumol, an organisation is always concerned about the sales level and declining sales
are always a serious concern for it. A firm will not be able to raise funds from market in such
situation. The distributors will not take pride in selling the products of firm and consumers may not
like to buy the firm’s products. The staff of the firm has to be reduced. On the other side if sales are
expanding the firm may get economies of scale and the profit base will also expand. The staff will get
incentives and bonuses with the increased level of sales. He further explained that revenue
maximization may be a goal for short run with the profit maximization goal in long run. But the sales
maximization is the long run as well as short run goal of the firms. Sales maximization is not only the
means but an end in itself.

4.1 Why Sales Maximization

Baumol felt that maximization of sales revenue should be the sole goal of firms, because:

i)The revenue is the only factor in the firms on which the salaries and perks of managers
depend.
ii) The status of the firms is measured in terms of the sales revenues they generate, not
the profits they earn.
iii) The future prospects of the firms in modern times are seen through its sales figures.
iv) The image and reputation of firm in the marketplace depends largely upon its sales
level.
v) The investors look at the sales figure of firm.
vi) The funds can be easily borrowed by maximum sales generating firms.

5. SUMMARY
The managers can’t altogether ignore the profits, as the survival of a business depends upon the
amount of profits it generates. But there are certain other considerations which have been stressed
by various theorists. O.E. Williamson supported the hypotheses of utility maximization, in which he
explained that the managers aim at maximizing their utility function and this utility function depends
upon staff, its expenditure, span of control, management slack and discretionary
investments.Baumol emphasized on sales maximization. He suggested that modern organisations
stress on maximizing the volume of sales instead of profits. He explained that the goodwill and
reputation of a firm largely depends upon the level of sales a firm is able to achieve. Certain
percentage of profits is needed to satisfy shareholders through dividend, to make investments, to
recover costs and to grow further. Thus the managers try to maintain a pre-determined level of profit
at the maximized point of sales. Kafolgis stressed on output maximization as a firm’s goal rather than
profit maximisation. Some economists suggested that all of these objectives are complementary
rather than contradictory to each other.
PROFIT AS BUSINESS OBJECTIVE AND PROFIT PLANNING

INTRODUCTION

The conventional theory of a firm assumes profit maximization as the sole objective of business
firms. Baumol, a nobel laureate, has, however, argued, “There is no reason to believe that all
businessmen pursue the same objective”1 . Recent researches on this issue reveal that the
objectives that business firms pursue are more than one. Some important objectives, other than
profit maximization, are: (a) maximization of sales revenue, (b) maximization of firm’s growth rate,
(c) maximization of manager’s utility function, (d) making satisfactory rate of profit, (e) long-run
survival of the firm, and (f) entryprevention and risk-avoidance. All business firms have undoubtedly
some organisational goals to pursue. What is the most common objective of business firms? There is
no definitive answer to this question. Perhaps the best way to find out the common objective of
business firms would be to ask the business executives. However, Baumol, a well–known authority
on business economics, has remarked that firms and their executives are often not clear about their
objectives. “In fact, it is common experience when interviewing executives to find that they will
agree to every plausible goal about which they are asked.”2 However, profit maximization is
regarded as the most common and theoretically most plausible objective of business firms. This
aspect will be discussed in detail later in the chapter. We will first discuss profit and profit
maximization as the objective of business firms in some details and then describe briefly the
alternative objectives of business firms.

ALTERNATIVE OBJECTIVES OF BUSINESS FIRMS

While postulating the objectives of business firms, the conventional theory of firm does not
distinguish between owners’ and managers’ interests. The recent theories of firm called ‘managerial’
and ‘behavioural’ theories of firm, however, assume owners and managers to be separate entities in
large corporations with different goals and motivation. Berle and Means16 were the first to point
out the dichotomy between the ownership and the management and its role in managerial
behaviour and in setting the goal(s) for the firm that they manage. Later on Galbraith17 wrote
extensively on this issue which is known as Berle-Means-Galbraith (B-M-G) hypothesis. The B-M-G
hypothesis states (i) that owner controlled firms have higher profit rates than manager controlled
firms; and (ii) that managers have no incentive for profit maximization. The managers of large
corporations, instead of maximizing profits, set goals for themselves that can keep the owners quiet
so that managers can take care of their own interest in the corporation. In this section, we will
discuss very briefly some important alternative objectives of business firms, especially of large
business corporations.

Baumol’s Hypothesis of Sales Revenue Maximization

Baumol18 has postulated maximization of sales revenue as an alternative to profitmaximization

objective. The reason behind this objective is the dichotomy between ownership and management
in large business corporations. This dichotomy gives managers an opportunity to set their goals
other than profit maximization goal which most owner-businessmen pursue. Given the opportunity,
managers choose to maximize their own utility function. According to Baumol, the most plausible
factor in managers’ utility functions is maximization of the sales revenue.

The factors which explain the pursuance of this goal by the managers are following.

First, salary and other earnings of managers are more closely related to sales revenue than to
profits.
Second, banks and financial corporations look at sales revenue while financing the corporation.

Third, trend in sale revenue is a readily available indicator of the performance of the firm. It helps
also in handling the personnel problem.

Fourth, increasing sales revenue enchances the prestige of managers while profits go to the owners.

Fifth, managers find profit maximization a difficult objective to fulfill consistently over time and at
the same level. Profits may fluctuate with changing conditions.

Finally, growing sales strengthen competitive spirit of the firm in the market and vice versa.

So far as empirical validity of sales revenue maximization objective is concerned, factual evidences
are inconclusive.19 Most empirical works are, in fact, based on inadequate data simply because
requisite data is mostly not available. Even theoretically, if total cost function intersects the total
revenue function (TR) function before it reaches its climax, Baumol’s theory collapses.

Besides, it is also argued that, in the long run, sales maximization and profit maximization objective
converge into one. For, in the long run, sales maximization tends to yield only normal levels of profit
which turns out to be the maximum under competitive conditions. Thus, profit maximization is not
incompatible with sales maximization.

Marris’s Hypothesis of Maximization of Firm’s Growth Rate

According to Robin Marris,20 managers maximize firm’s balanced growth rate subject to managerial
and financial constraints. He defines firm’s balanced growth rate (G) as

G = GD = GC

where GD = growth rate of demand for firms product and GC = growth rate of capital supply to the
firm.

In simple words, a firm’s growth rate is balanced when demand for its product and supply of capital
to the firm increase at the same rate. The two growth rates are according to Marris, translated into
two utility functions: (i) manager’s utility function, and (ii) owner’s utility function.

The manager’s utility function (Um) and owner’s utility function (Uo) may be specified as follows.

Um = f (salary, power, job security, prestige, status),

and Uo = f (output, capital, market-share, profit, public esteem).

Owners’ utility function (Uo) implies growth of demand for firms product and supply of capital.
Therefore, maximization of Uo means maximization of ‘demand for firm’s product’ or growth of
capital supply’. According to Marris, by maximizing these variables, managers maximise both their
own utility function and that of the owners. The managers can do so because most of the variables
(e.g., salaries, status, job security, power, etc.) appearing in their own utility function and those
appearing in the utility function of the owners (e.g., profit, capital market, share, etc.) are positively
and strongly correlated with a single variables, i.e., size of the firm. Maximization of these variables
depends on the maximization of the growth rate of the firms. The managers, therefore, seek to
maximize a steady growth rate.

Marris’s theory, though more rigorous and sophisticated than Baumol’s sales revenuemaximization,
has its own weaknesses. It fails to deal satisfactorily with oligopolistic interdependence. Another
serious shortcoming of his model is that it ignores price determination which is the main concern of
profit maximization hypothesis. In the opinion of many economists, Marris’s model too, does not
seriously challenge the profitmaximization hypothesis.
Williamson’s Hypothesis of Maximization of Managerial Utility Function

Like Baumol and Marris, Willamson21 argues that managers have discretion to pursue objectives
other than profit maximization. The managers seek to maximize their own utility function subject to
a minimum level of profit. Managers’ utility function(U) is expressed as

U = f(S, M, ID)

Where S = additional expenditure on staff

M = managerial emoluments,

ID = discretionary investments

According to Williamson’s hypothesis, managers maximize their utility function subject to a

satisfactory profit. A minimum profit is necessary to satisfy the shareholders or else manager’s job
security is endangered.

The utility functions which managers seek to maximize include both quantifiable variables like salary
and slack earnings, and non- quantitive variable such as prestige power, status, job security,
professional excellence, etc. The non-quantifiable variables are expressed, in order to make them
operational, in terms of expense preference defined as ‘satisfaction derived out of certain types of
expenditures’ (such as slack payments), and ready availability of funds for discretionary investment.

Like other alternative hypotheses, Williamson’s theory too suffers from certain weaknesses. His
model fails to deal with the problem of oligopolistic interdependence. Williamson’s theory is said to
hold only where rivalry between firms is not strong. In case of strong rivalry, profit maximization is
claimed to be a more appropriate hypothesis. Thus, Williamson’s managerial utility function too
does not offer a moresatisfactory hypothesis than profit maximization.

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