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Separation of ownership and management combined with the desire for steady performance which ensures satisfactory profits, tend to make the managers risk avoiders. Top Managers in the modern firm are generally reluctant to adopt highly promising but risk-prone projects. But this approach stabilises the economic performance of the firm and leads to development of orderly markets.
The Managers have other ideas. Their utility function includes variables such as Salaries, Job security, Power and status.
There are two constrains in the Marriss Model: 1. The Managerial Team Constraint. Since Management is a teamwork, hiring new managers does not expand managerial capaqcity immediately. New managers take time to get integrated in the team. Managerial tream constraint sets limits to both the rate of growth of demand and rate of growth of capital. 2. The Job Security Constraint. Managers want job security. Job security attained by pursuing a prudent financial policy which requires the three crucial financial ratios to be maintained at optimum levels.
Liquidity Ratio: Current ratio ratio of liquid assets to total assets. Low liquidity increases the risk of insolvency (risk=+ve) Leverage/Debt or Debt-Equity ratio: ratio of debt to total assets. High debt-equity ratio exposes the firm to bankruptcy.(risk=+ve) Profit retention ratio: High retention of profits, adds to the reserves contributing to the growth of capital.(risk= -ve) Combining all the above into a single parameter will amount to financial constraint of the firm.
Marriss Model: The rate of growth of demand for the products of the firm:
The firm is assumed to grow by diversification and not by merger or acquisition. The growth of demand for the products of the firm depends on the rate of diversification and the proportion of successful new products. The rate of growth of capital supply: The shareholders who are the owners, wish to maximise company's capital, which is the measure of the size of the firm. The main source of finance for the growth of the firm is profit but the management can retain only part of it, for another part has to be distributed as dividend. The rate of growth of capital is determined by three factors: the three financial ratios determined by the managers constituting the financial security constraint, the average rate of profit, and the rate of diversification.
Basic concepts:
Various concepts of Profit: The actual profit: Sales Revenue minus production costs and less staff expenditure. =RCS The reported Profit : is the profit that the firm reports to the tax authorities. It is the actual profit less tax deductible managerial emoluments.(M) = -M =RCS-M