The traditional theory does not distinguish between owners and managers’ interests. The recent theories of firm, which are also called managerial and behavioral theories of firm, assume owners and managers to be separate entities in large corporations with different goals and motivation. In this section, some important alternative objectives of business firms, especially of large business corporations are also discussed.
1. Baumol’s Hypothesis of Sales Revenue Maximization
According to Baumol, “maximization of sales revenue is an alternative to profit maximization objective“. The reason behind this objective is to clearly distinct ownership and management in large business firms. This distinction helps the managers to set their goals other than profit maximization goal. Under this situation, managers maximize their own utility function. According to Baumol, the most reasonable factor in managers utility functions is maximization of the sales revenue.
The factors, which help in explaining these goals by the managers, are following:
- Salary and other earnings of managers are more closely related to seals revenue than to profits.
- Banks and financial corporations look at sales revenue while financing the corporation.
- Trend in sale revenue is a good indicator of the performance of the business firm. It also helps in handling the personnel problems.
- Increasing sales revenue helps in enhancing the prestige of managers while profits go to the owners.
- Managers find profit maximization a difficult objective to fulfill consistently over time and at the same level. Profits may fluctuate with changing conditions.
- Growing sales strengthen competitive spirit of the business firm in the market and vice versa.
So far as empirical validity of sales revenue maximization objective is concerned, realistic evidences are unsatisfying. Most empirical studies are, in fact, based on inadequate data because the necessary data is mostly not available. If total cost function intersects the total revenue (TR) function before it reaches its highest point, Baumol’s theory fails. It is also argued that, in the long run, sales maximization and profit maximization objective can be merged into one. In the long run, sales maximization lends to yield only normal levels of profit, which turns out to be the maximum under competitive conditions. Thus, profit maximization is not inequitable with sales maximization objective.
Read More: Baumol’s Sales Revenue Maximization Model
2. Marris’s Hypothesis of Maximization of Firm’s Growth Rate
According to Robin Marris, managers maximize firm’s growth rate subject to managerial and financial constraints. Marris defines firms balanced growth rate (G) as follows:
G = Gd = Gc
- Gd = growth rate of demand for firms product.
- Gc = growth rate of capital supply to the firm.
In simple words, a firm’s growth rate is considered to be balanced when demand for its product and supply of capital to the firm increase at the same rate. The two growth rates according to Marris, are translated into two utility functions such as:
- Manager’s utility function
- 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).
Owner’s utility function (Uo) implies growth of demand for firms’ products and supply of capital. Therefore, maximization of Uo mans maximization of demand for a firm’s products or growth of supply of capital.
According to Marris, by maximizing these variables, managers maximize both their utility function and that of the owner’s. The, managers can do so because most of the variables such as salaries status, job security, power, etc., appearing in their own utility function and those appearing in the utility function of the owners such as profit, capital market, share, etc. are positively and strongly correlated with the size of the firm. These variables depend 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 accurate and sophisticated than Baumol’s sales revenue maximization has its own weaknesses. It fails to deal satisfactorily with the market condition of oligopolistic interdependence. Another serious shortcoming is that it ignores price determination, which is the main concern of profit maximization hypothesis. In tbe opinion of many economists, Marris’s model too, does not seriously challenge the profit maximization hypothesis.
3. Williamson’s Hypothesis of Maximization of Managerial Utility Function
Like Baumol and Marris, Williamson argues that managers are very careful in pursuing the 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 below:
U = f(S, M, ID)
- 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 and also to secure the job of managers. The utility functions which managers seek to maximize include both quantifiable variables like salary and slack earnings anti non-quantitative variable such as prestige power, status, job security, professional excellence, etc. The non-quantifiable variables are expressed in order to make them work effectively in terms of expense preference defined as satisfaction derived out of certain types of expenditures. 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 there is strong rivalry, profit maximization is claimed to be a more appropriate hypothesis. Thus, Williamson’s managerial utility function too does not offer a more satisfactory hypothesis than profit maximization.
4. Cyert-March Hypothesis of Satisfying Behavior
Cyert-March hypothesis is an extension of Simon’s hypothesis of firms’ satisfying behavior Simon had argued that the real business world is full of uncertainties. Accurate and adequate data are not readily available. If data are available, managers have little time and ability to process them. Managers also work under a number of constraints. Under such conditions it is not possible for the firms to act in terms of consistency assumed under profit maximization hypothesis. Nor do the firms seek to maximize sales and growth. Instead they seek to achieve a satisfactory profit or a satisfactory growth and so on. This behavior of business firms is termed as satisfaction behavior.
Cyert and March added that, apart from dealing with uncertainty, managers need to satisfy a variety of groups of people such as managerial staff, labor, shareholders, customers, financiers, input suppliers, accountants, lawyers, etc. All these groups have conflicting interests in the business firms. The manager’s responsibility is to satisfy all of them. According to the Cyert-March, “firm’s behavior is satisfying behavior which implies satisfying various interest groups by sacrificing firm’s interest or objectives.” The basic assumption of satisfying behavior is that a firm is an association of different groups related to various activities of the firms such as shareholders, managers, workers, input supplier, customers, bankers, tax authorities, and so on. All these groups have some expectations from the firm, which are needed to be satisfied by the business firms. In order to clear up the conflicting interests and goals, managers form an objective level of the firm by taking into consideration goals such as production, sales and market, inventory and profit.
These goals and objective level are set on the basis of the managers past experience and their assessment of the future market conditions. The objective level is also modified and revised on the basis of achievements and changing business environment. But the behavioral theory has been criticized on the following grounds:
- Though the behavioral theory deals with the activities of the business firms, it does not explain the firm’s behavior under dynamic conditions in the long run.
- It cannot be used to predict the firm’s activities in the future.
- This theory does not deal with the equilibrium of the business industry.
- This theory fails to deal with interdependence of the firms and its impact on firms behavior.
5. Rothschild’s Hypothesis of Long-Run Survival and Market Share Goals
Rothschild suggested another alternative objective and alternative to profit maximization to a business firm. According to Rothschild, the primary goal of the firm is long-run survival. Some other economists have suggested that attainment and retention of a market share constantly, is an additional objective of the business firms. The managers, therefore, seek to secure their market share and long-run survival. The firms may seek to maximize their profit in the long run though it is not certain.
The evidence related to the firms to maximize their profits in the long run, is not certain. Some economists argue that if management is kept separate from the ownership, the possibility of profit maximization is reduced. This means that only those firms with the objective of profit maximization can survive in the long run. A business firm can achieve all other subsidiary goals easily by maximizing its profits. The motive of business firms behind entry-prevention is also to secure a constant share in the market. Securing constant market share also favors the main objective of business firms of profit maximization.
Credit: Managerial Economics-MGU