ObjectivesOfFirms

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Unit6
Structure
6.1 Introduction Objectives 6.2 ProfitMaximizationmodel SelfAssessmentQuestion1 6.3 EconomistTheoryoffirm SelfAssessmentQuestions2 6.4 CyertandMarchsbehaviortheory SelfAssessmentQuestions3 6.5 Marrisgrowthmaximizationmodel SelfAssessmentQuestions4 6.6 Boumalsstaticanddynamicmodels SelfAssessmentQuestions5 6.7 Williamsonsmanagerialdiscretionarytheory SelfAssessmentQuestions6 6.8 Summary TerminalQuestions AnswertoSAQsandTQs 6.1. Introduction

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Abusinessfirmisaneconomicunit.Itisaproducingunit.Itconvertsinputsintooutputs.Itis a legalentityonthebasisofownershipandcontractualrelationshiporganizedforproductionandsale 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. Theyproduce and supply different goods and servicesfor the direct satisfactionof consumersforproducingotherfinalgoodsandservices. Eachfirmlaysdownitsownobjectives.Theyarefundamentaltotheveryexistenceofafirm.They aretheendpointtowardsrationalactivity.Theyindicatetheveryexistenceofafirmandguidethe
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actionsofafirm.Theyindicatehowafirmhastoorganizeitsactivitiesandperformitsfunctions.A modembusinessunithasmultipleobjectivesandtheyaremultidimensionalintheirnature.Someof themarecompetitivewhileothersaresupplementaryinnature.Afewotherobjectivesaremutually interconnectedandafewothersareopposinginnature.Theseobjectivesaredeterminedbyvarious factorsandforceslikecorporateenvironment,socioeconomicconditions,andthenatureofpowerin the organization and extraneous conditions, and constraints under which a firm operates. Each businessunitdefinesitsownobjectiveswhichmayhavetosatisfytheneedsofthosegroupswhose cooperation makes the continued existence of the business possiblethe share holders, management, employees, suppliers and consumers etc. Thus, we come across multiple and diversifiedobjectives. LearningObjectives: Afterstudyingthisunit,youshouldbeabletounderstandthefollowing 1. Tounderstandthebackgroundunderwhichafirmlaysdownitsmultipleobjectives. 2. To explain how modern business units instead of having a single objective has several objectives. 3. Toanalyzehowprofitmaximizationisthebasicobjectiveofafirmeventoday. 4. To describe many objectives like maximizing sales revenue of the firm, maximizing the growth rateofthefirm,maximizingtheutilityfunctionsofmanagersetc. Economistsover aperiod oftime havedeveloped various theories and models to explain different kindsofgoalsofmodernfirms.Broadlyspeakingtheycanbedivedintothreegroups.Theyareas follows 1. Theprofitmaximizationmodel. 2. Managerialtheoriesormodels 3. Behavioraltheoriesormodels. Letusstudysomeoftheimportanttheoriesundereachcategory. 6.2ProfitMaximizationModel Profitmakingisoneofthemosttraditional,basicandmajorobjectivesofafirm.Profitmotiveisthe drivingforce behind all business activities of a company. It is the primary measure of success or failureofafirminthemarket.Profitearningcapacityindicatestheposition,performanceandstatus ofafirm in the market. It isanacid test of economic ability andperformanceofan individualfirm. There is no place for a firm unless it earns a reasonable amount of profit in the business. It is
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necessary to stay in business and maintain in tact the wealth producing agents. It is a widely acceptedgoalandthereisnothingbadorimmoralaboutit.Earlierprofitmaximizationwasthesole objectiveofafirm.Thisassumptionhasalonghistoryineconomicliteratureandtheconventional pricetheorywasbasedonthisveryassumptionaboutprofitmaking.Inspiteofseveralchangesand developmentofseveralalternativeobjectives,profitmaximizationhasremainedasoneofthesingle most importantobjectivesof thefirm even today. Both small and largefirms consistently make an attempttomaximizetheirprofitbyadoptingnoveltechniquesinbusiness.Specificeffortshavebeen made to maximize output and minimize production and other operating costs. Cot reduction, cost cuttingandcostminimizationhasbecomethesloganofamodernfirm. Ithelpstopredictthepriceoutputbehaviorofafirmunderchangingmarketconditionsliketaxrates, wagesandsalaries,bonus,thedegreeofavailabilityofresources,technology,fashions,tastesand preferencesofconsumersetc.Itisaverysimpleandunambiguousmodel.Itisthesinglemostideal 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 profitmaximization hypothesis. This model gives a proper insight in to the working behavior of a firm. There are well developedmathematicalmodelstoexplainthishypothesisinasystematicandscientificmanner. Mainpropositionsoftheprofitmaximizationmodel. The model is based on the assumption that each firm seeks to maximize its profit given certain technicalandmarketconstraints.Thefollowingarethemainpropositionsofthemodel. 1. Afirmisaproducingunitandassuchitconvertsvariousinputsintooutputsofhighervalueunder agiventechniqueofproduction. 2. Thebasicobjectiveofeachfirmistoearnmaximumprofit. 3. Afirmoperatesunderagivenmarketcondition. 4. Afirmwillselectthatalternativecourseofactionwhichhelpstomaximizeconsistentprofits 5. Afirmmakesanattempttochangeitsprices,inputandoutputquantitytomaximizeitsprofit. Themodel Profitmaximizationimpliesearninghighestpossibleamountofprofitsduringagivenperiod of time. A firm has to generate largest amount of profits by building optimum productive capacity bothintheshortrunandlongrundependinguponvariousinternalandexternalfactorsandforces. Thereshouldbeproperbalancebetweenshortrunandlongrunobjectives.Intheshortrunafirmis able to make only slight or minor adjustments in the production process as well as in business

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conditions.Theplantcapacityintheshortrunisfixedandassuch,itcanincreaseitsproductionand salesbyintensiveutilizationofexistingplantsandmachineries,havingovertimeworkfortheexisting staffetc.Thus,intheshortrun,afirmhasitsowntechnicalandmanagerialconstraints.Butinthe longrun,asthereisplentyoftimeatthedisposalofafirm,itcanexpandandaddtotheexisting capacities, build up new plants, employ additional workers etc to meet the rising demand in the market.Thus,inthelongrun,afirmwillhaveadequatetimeandampleopportunitytomakeallkinds ofadjustmentsandreadjustmentsinproductionprocessandinitsmarketingstrategies. Itistobenotedwithgreatcarethatafirmhastomaximizeitsprofitsaftertakingintoconsideration ofvariousfactorsintoaccount.Theyareasfollows 1. Pricingandbusinessstrategiesofrivalfirmsanditsimpactontheworkingofthegivenfirm. 2. Aggressivesalespromotionpoliciesadoptedbyrivalfirmsinthemarket. 3. Withoutinducingtheworkerstodemandhigherwagesandsalariesleadingtoriseinoperation costs. 4. Without resorting to monopolistic and exploitative practices inviting government controls and takeovers. 5. Maintainingthequalityoftheproductandservicestothecustomers. 6. Takingvariouskindsofrisksanduncertaintiesinthechangingbusinessenvironment. 7. Adoptingastablebusinesspolicy. 8. Avoiding any sort of clash between short run and long run profits in the business policy and maintainingproperbalancebetweenthem. 9. Maintainingitsreputation,name,fameandimageinthemarket. 10. Profitmaximizationisnecessaryinbothperfectandimperfectmarkets.Inaperfectmarket,a firmisapricetakerandunderimperfectmarketitbecomesapricesearcher. Assumptionsofthemodel Theprofitmaximizationmodelisbasedontreeimportantassumptions.Theyareasfollows 1.Profitmaximizationisthemaingoalofthefirm. 2.Rationalbehavioronthepartofthefirmtoachieveitsgoalofprofitmaximization. 3.Thefirmismanagedbyownerentrepreneur. Determinationofprofitmaximizingpriceandoutput Profitmaximizationofafirmcanbeexplainedintwodifferentways. a. TotalRevenueandTotalCostapproach.

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b. MarginalRevenueandMarginalCostapproach. Profitsofafirmareestimatedbymakingcomparisonbetweentotalrevenueandtotalcosts.Profitis thedifferencebetweenTRandTC.Inotherwords,excessofrevenueovercostsistheprofits.Profit =TRTC.IfTRisequaltoTCinthatcase,therewillbebreakevenpoint.IfTRislessthanTC,in that case,afirm will be incurring losses. In thiscase, we take in toaccount of total cost andtotal revenueofthefirmwhilemeasuringprofits. ItisclearfromthefollowingdiagramhowprofitariseswhenTRisgreaterthanthatofTC

N1

TC

Cost/Revenue

TR

N2

Output

2.MRandMCapproach Inthiscase,wetakeintoaccountofrevenueearnedfromoneunitandcostincurredtoproduceonly oneunitofoutput.AfirmwillbemaximizingitsprofitswhenMR=MCandMCcurvecutsMRcurve frombelow.IfMCcurvecutsMRcurvefromaboveeitherunderperfectmarketorunderimperfect market,nodoubtMRequalsMCbuttotaloutputwillnotbemaximizedandhencetotalprofitsalso willnotbemaximized.Hence,twoconditionsarenecessaryforprofitmaximization 1.MR=MC.2.MCcurvecutMRcurvefrombelow.Itisclearformthefollowingdiagram.

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MC

P1 MR

Output

Q1

MC

N1 MR

Output

Q1

Justificationforprofitmaximization 1. Basicobjectiveoftraditionaleconomictheory.Thetraditionaleconomictheoryassumesthat a firm is owned and managed by the entrepreneur himself and as such he always aims at maximumreturnonhiscapitalinvestedinthebusiness.Henceprofitmaximizationbecomesthe naturalprincipleofafirm. 2. Afirmisnotacharitableinstitution.Afirmisabusinessunit.Itisorganizedoncommercial principles. A firm is not a charitable institution. Hence, it has to earn reasonable amount of profits. 3. Topredictmostrealisticpriceoutputbehavior. Thismodelhelpstopredictusualandgeneral behaviorofbusinessfirms in the real world as it providesa practicalguidance. It also helps in predictingthereasonablebehaviorofafirmwithmoreaccuracy.Thus,itisaverysimple,plain, realistic,pragmaticandmostusefulhypothesisinforecastingpriceoutputbehaviorofafirm.
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4. NecessaryforsurvivalItistobenotedthattheveryexistenceandsurvivalofafirmdependson its capacity to earn maximum profits. It is a timehonored hypothesis and there is common agreementamongbusinessmentomakehighestpossibleprofitsbothintheshortrunandlong run. 5. Toachieveotherobjectives.Inrecentyearsseveralotherobjectiveshavebecomemuchmore popularandalltheseobjectiveshavebecomehighlyrelevantinthecontextofmodernbusiness set up. But it is to be remembered that they can be achieved only when a firm is making maximumprofits. Criticisms 1. Ambiguous term. The term profit maximization is ambiguous in nature. There is no clear cut explanationwhetherafirmhastomaximizeitsnetprofit,totalprofitortherateofprofitinabusiness unit.Againmaximumamountofprofitcannotbepreciselydefinedinquantitativeterms. 2.Alwaysitmaynotbepossible.Profitmaximization,nodoubtisthebasicobjectiveofafirm.But inthecontextofhighlycompetitivebusinessenvironment,alwaysitmaynotbepossibleforafirmto achieve this objective. Other objectives like sales maximization, market share expansion, market leadershipbuildingitsownimage,name,fameandreputation,spendingmoretimewithmembersof thefamily,enjoyingleisure,developingbetterandcordialrelationshipwithemployeesandcustomers etc.alsohasassumedgreatersignificanceinrecentyears. 3. Separation of ownership and management. In many cases, today we come across the businessunitsareorganizedonpartnershiporjointstockcompanyorcooperativebasis.Incaseof 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 maximizationmaynotbecomepossible. 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 takerightdecisionsinahighlyfluctuatingbusinessscenario.Hence,profitsmaynotbemaximized. 5. Conflict in interdepartmental goals. A firm has several departments and sections headedby expertsintheirownfields.Eachoneofthemwillhaveitsownindependentgoalsandmanyatimes there is possibility of clashes between the interests of different departments and as such always profitsmaynotbemaximized.

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6.Changesinbusinessenvironment.Inthecontextofhighlycompetitiveandchangingbusiness environmentandchangesinconsumerstastesandrequirements,afirmmaynotbeabletocopeup withtheexpectationsandadjustitspoliciesandassuchprofitsmaynotbemaximized. 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 marketandthesmallfirmshavetofollowthepoliciesoftheleadingfirms.Hence,inmanycases, therearelimitedchancesformakingmaximumprofits. 8. Significance of other managerial gains. Salaried managers have limitedfreedom in decision makingprocess.Someofthemareunabletoforecasttherighttypeofchangesandmeetthemarket challenges.Theyaremoreworriedabouttheirsalaries,promotions,perquisites,securityofjobs,and othertypesofbenefits.Theymaylackstrongmotivationstomakehigherprofitsasprofitswouldgo to the organization. They may be contented with only satisfactory level of profits rather than maximumprofits. 9.Emphasisonnonprofitgoals.Manyorganizationsgivemorestressonnonprofitgoals.From the point of view of todays business environment, productivity, efficiency, better management, customersatisfaction,durabilityofproducts,higherqualityofproductsandservicesetchavegained importance to cope with business competition. Hence, emphasis has been shifted from profit maximizationtootherpracticalaspects. 10. Aversion to reduction in power. In case of several small business units, the owners do not wanttosharetheirpowerswithmanynewpartnersandhence,theytrytokeepmaximumpowersin theirhands.Insuchcases,keepingmorepowerbecomesmoreimportantthanprofitmaximization. 11. Official restrictions over profits of public utilities. Public utilities or public corporations are legallyprohibitedtomakehugeprofitsinmanydevelopingcountrieslikeIndia. Thus, it is clear that afirm cannot maximize its profits always. There are many constraints in the backgroundofmultipleobjectives. Eachoneoftheobjectiveshasitsownmeritsanddemeritsanda firmhastostrikeabalancebetweenallkindsofobjectives.However,todayitistheviewofmany 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,afirmshouldhavesufficientrevenue.Otherwiseallotherobjectiveswouldremainonlyon paper and cannever be implemented. Nonprofitgoals serve as supplementary or complementary

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ones to the primary objective of profit maximization Thus, the traditional objective of profit maximizationhasrelevanceeventodayofcoursewithsomemodifications. SelfAssessmentQuestions1

1. In_____________model,theimportantassumptionisthattheentrepreneuraimsatmaximising
hisprofits.

2. _________isthepointwherethefirmhasstoppedincurringlossesbutyettostartgainingprofit. 3. ThefullformofTRis___________
6.3EconomistTheoryOfFirm AccordingtoEconomisttheoryoffirm,afirmisaproducingunit.Ittransformsorconvertsallkindsof 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 organizedon commercial principles. In the processof productionandsaleofdifferentgoodsandservices,itaimsatmakingprofits. According to this theory, a traditional firm is a group with a particular organizational and managementstructurehavingcommandoveritsownpropertyrights.Itisalegalentityonthe basis of ownership and contractual relationship organized for production and sale of goods and services.Inoldendaysafirmwascalledbyvariousnameslikeshops,firms,enterprise,production andbusinessconcernsetc.Buttoday,itisorganizedonvariousformslikeasoletrader,partnership concern,JointStockCompany,cooperativesocietyetc. Afirmisformed,runandmanagedbyanowner,employeroranentrepreneurwhohasthefollowing characteristics. 1. Hehasthelegalpermissiontorunanenterprise. 2. Hecanenterintocontractwithanygroupofpeoplewhosupplyproductiveresources. 3. Hecantakehisowndecisionstomaximizehiseconomicgains. 4. Heisentitledtoenjoytheresidualincomeaftermakingpaymentstoallproductiveresourcesin theformofrent,wagesandsalariesandinterest. 5. Hecantransferhisrightsandobligationstootherindividualsonthebasisofcontracts.

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6. Hecandirectanddictatethesuppliersofproductiveresourcesinthemannerhelikesofcourse onthebasisoflegalcontracts. 7. Hecanchangethenatureofmanagementaccordingtohisconvenience. 8. Hehasalltherightstomakechangesinhisorganizationwhichhefeelsthebest.Hecanconsult othersorhecantakehisownfinaldecisions. Thus,afirmismanagedbyaprivatepersonwhocentralizesallhisdecisionsonthebasisoflegal contracts and makes enough profits. He has his own personal interests to run the business unit. Suchatypeofbusinessunithasemergedasadominantformofbusinessorganizationoveraperiod oftime.Ithasitswonadvantagesasthefirmismanagedbyanindividual. Afirmmanagedbyanindividualhasseveraladvantagesoverotherformsoforganization. 1. Hecantakeimmediateandquickdecisionstomaximizehiseconomicgains. 2. Direct control over the firm will ensure higher productivity, efficiency, better supervision, better performanceetc.Bettercontrolandmanagementhelpshimtohavetimeboundprograms 3. Hecanrewardfactorinputsonthebasisoftheirperformanceandgetbestservicesfromthem. 4. Headoptsaflexiblebusinesspolicytosuitthechangingconditionswithoutanyoflossoftime. Thus,thisformofbusinessorganizationhasemergedastheclassicalentrepreneurialfirmandhas becomemostpopularoveraperiodoftime.Theabovementionedfeaturesoftheclassicalfirmhave beendescribedasthetheoryoffirmbyvariouseconomists. Thetraditionalorclassicalfirmbasicallyengagesitselfinvariouskindsofeconomicactivitieswhich help in maximizing its profits. It concentrates on wealthcreation and through it surplus creation. Surplus value is nothing butthe difference betweenthe value of thefinalproduct 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 combinationstoavoidallkindsofwastages,cutdowncostsandmaximizeitsoutput.Whenthefirm produces maximum output with minimum costs then it will reach the equilibrium position. This is possiblewhentotalrevenueisequaltototalcostormarginalrevenueisequaltomarginalcost.At theequilibriumpoint,itissaidthatafirmwillbemaximizingitsprofits.Thenatureofworkingofafirm dependsonseveralfactorslikenumberoffirmsinthemarket,sizeofthefirm,volumeofproduction, entryandexitiffirms,degreeofcompetition,existenceofalternativesubstitutes,pricesofgoodsetc. Thus,thetraditionalorclassicalfirmaimsatprofitmaximizationandovertheyearsthisobjectivehas beenreplacedbyprofitoptimization.

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SelfAssessmentQuestions2 1. AccordingtoEconomistTheoryOfFirm,afirmisa____unit,whichconvertsinputintooutputand whiledoingso,triestocreatesurplusvalue. 2. Thefirmaimingforprofitmaximizationreachesitsequilibriumonlywhenitproduces_________. 3. Businessdecisionsaremadetocopewith_____ 6.4CyertAndMarchsBehaviorTheory Another alternative nonprofit maximizing theory has been developed by Cyert and March. The theorymakesanattempttoexplainthebehaviorofintergroupconflictsandtheirmultipleobjectives inanorganization.Basically,thistheoryexplainstheusualandnormalbehaviorofdifferentgroupsof peoplewhoworkinanorganizationhavingmutuallyoppositegoals.Prof,Simonhasdevelopedthe initialbehavioralmodelandProf.CyertandMarchhavefurtherelaboratedthetheoryintheirbook BehavioralTheoryoftheFirmpublishedin1963. CyertandMarchexplainhowcomplicateddecisionsaretakeninbigindustrialhousesundervarious 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 internalworkingofabigandmultiproductfirmdiffersfromthatofsmallorganizations.Thevarious kinds of internal conflicts and problems faced by these organizations would certainly affect the decisionmakingprocessoftheseorganizations.Theyalsoexplainhowtherearecertaincommon problems faced by similar organizations in an industry and their effects on the internal working of eachindividualorganizationandtheirdecisionmakingprocess. CyertandMarchconsiderthatamodernfirmisamultiproduct,multigoalandmultidecisionmaking coalitionbusinessunit.Likeacoalitiongovernment,itismanagedbyanumberofgroups.Thegroup consists of share holders, managers, workers, customers, suppliers, distributors, financiers, legal expertsandsoon.Eachgroupisindependentbyitselfandhasitsownsetofobjectivesandtheytry tomaximizetheirindividualbenefits.Forexample,shareholdersexpectfastergrowthofthecompany and higher dividends, workers expect maximum wages and minimum work, better working conditions,welfaremeasures,managerswanthighersalary,greaterpower,autonomyindaytoday working,dominance,controletc,suppliersquickandimmediatepaymentsetc.contributionsmadeby each one of the group is equally important in carrying the activities of a firm. In their view out of

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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 relativestrengthandimportanceofeachgroupinanorganization,aspirationandexpectationlevelof eachgroup,pastsuccessintheirdemands,relativesuccessofothergroupsbothwithinandoutside theorganizationetc.Itisquiteclearthatgoalsofeachoneofthegroupismultiple,conflictingand oppositeintheirnature.Eachoneofthegroupoutoftheirpastexperienceandsuccess,availability oflimitedresourcesatthedisposalofafirm,wouldarrangetheirdemandonthebasisofpriorities. Mosturgentdemandsarehighlightedandlowprioritydemandsarepostponedtolatterperiods.The managementmayhonorafewdemandsofafewgroupsandpostponethedemandsofothergroups inviewoffinancialconstraints.Thismaycreateheartburnsandconflictbetweendifferentgroupsin thesameorganization. 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. Asall of them change over a period of time, the demands ofeach groupwouldalsoundergochanges.Ifactualperformanceandachievementsoftheorganizationis muchbetterthanexpectedaspirationsandtargetlevel,inthatcase,therewillbeupwardrevisionin their demands and viceversa. Thus, there is a strong linkage between the expected and actual demandofeachgroupintheorganization,pastsuccessandfutureenvironment.Eachgroupmakes anattempttoachieveitsdemandinitsownway.Throughtheprocessofhardbargaining,awinning coalitionisformedandthebroadobjectivesaresetoutbythemanagement.Theremaybeconflictin differentobjectivesofdifferentgroupsandthemanagementhastoovercomethemintelligently. Cyert and March suggest the following methods to overcome the conflicts of different groups and smoothworkingoftheorganization.Theyareasfollows.Demandsofeachgroupmaybeseparated fromthatoftheotherandseparateattemptsaremadetofulfillthemsothattheirimpactonthewhole organizationmaybeavoided.Forexample,theywouldgranthighermonetaryrewardsforvarious 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,Forexample,morefundsmaybereleasedtoR&D,buyingcomputers&otherequipments etc. share holders may be granted higher dividends, managers are given more powers, more

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autonomy,highersalaries,lavishandluxuriousairconditionedoffices,vehicles,andvariouskindsof facilities to keep them happy. They are called as slack payments. Certainly, it will have stabilizing effectsontheworkingofanorganizationasitwillbuildupthemoraleofthetopmanagement.These additionalbenefitsmaybeflexibletosuittotheprofitandlossconditionsofafirm. 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 sequentialattention.Onthebasisofthepriorityandimportanceofeachdemand,themanagement mayfulfillmosturgentdemandfirstandthenpostponetheremaininglessurgentones. Themanagementmayalsotackletheproblembydecentralizingthedecisionmakingprocess.Itcan give more autonomy to each department to work out its program, avoid mutual conflicts, ensure harmonyandbalanceindifferentgoals,andoptimizeitsworking. CyertandMarchareoftheopinionthatoutofseveralobjectivesafirmhasfiveimportantgoals.They are 1. Production goal. Production is tobeorganizedon thebasis of demand in the market. Neither there should be over production nor under production but just that much to meet the required demandinthemarket,avoidexcesscapacity,overutilizationofcapitalassets,layoffofworkers 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 demandandsupplyistobemaintained. 3. Salesgoal.Thereshouldbeadequatesalesinanyorganizationtoearnreasonableamountsof profits.Inordertocreatedemandsalespromotionpoliciesmaybeadoptedfromtimetotime. 4. Marketshare goal. Each firm has to make consistent effort to increase its market share to competesuccessfullywithotherfirmsandmakesufficientprofits 5. Profitgoal.Thisisoneofthebasicobjectivesofanyfirm.Theverysurvivalandsuccessofthe firmwoulddependuponthevolumeofprofitsearnedbyit. The above mentioned objectives also would under go changes over a period of time in the backgroundofmodernbusinessenvironment.Hence,decisionmakingwouldbecomecomplexand complicated.

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Itisquiteclearthateachbusinessorganizationhasitsownsetofgoals.Thesegoalswoulddepend ontheeverchangingdemandsofdifferentgroupswhohavetheirownconflictingobjectives.Thereis needfor harmonious and balanced blending ofdifferent 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 accommodateasmanyaspossibledemandsofdifferentgroupswithoutjeopardizingitsownbasic goalofmakingprofitsThemodeldevelopedbyCyertandMarchisalsosimilartothatofthemodel developed by prof. Simon. The model highlights on satisfactory levels of performance and achievementsofitsmultipleobjectivesasmaximizationofdifferentgoalsmaynotbepossibleinthe contextofcomplexbusinessworld.Hence,makingsatisfactorylevelsofprofitsratherthanmaximum profitshasbecometheorderoftheday. Onthebasisofitsperformance,thegoalsareset.Ifthetargetgoalsarenotachieved,inthatcaseit makesanattempttosearchthereasonsforitsfailureandonthebasisofexperienceitrevisesits goal.Suitablechangesaremadeinitsobjectives,targets,andstrategiestoachievetheminagiven timeframe.Ifthemodifiedobjectivesareachieveddrasticchangesinthembecomeinevitable.The top management takes the decisions in the background of limited time, resources, knowledge, informationanddata.Itistoodifficultforthemtoexaminethemeritsanddemeritsofallavailable 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 rationalinnature Demerits. 1. The theory fails to analyze the behavior of the firm but it simply predicts the future expected behaviorofdifferentgroups. 2. Itdoesnotexplainequilibriumoftheindustryasawhole. 3. Itfailstoanalyzetheimpactofthepotentialentryofnewfirmsintotheindustryandthebehavior ofthewellestablishedfirmsinthemarket. 4. It highlights only on short run goals rather than long run objectives of an organization. Thus, therearecertainlimitationstothistheory. SelfAssessmentQuestions3 1.______isrelatedtodemandofsalesmanagementandsalesdecision.

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2. ________isrelatedtopriceandresourceallocationdecisions. 3. ____worksasashockabsorber. 4. ____and___typesofresolvingconflictsarequalitative. 5. CyertandMarchpointsoutthatthecoalitiongrouphasmultiple,_____and________goals 6.5MarrisGrowthMaximizationModel Profitmaximization is a traditionalobjective of afirm.Sales maximization objective isexplainedby Prof.Boumal.Onsimilarlines,Prof.Marrishasdevelopedanotheralternativegrowthmaximization modelinrecentyears.Itisacommonfactortoobservethateachfirmaimsatmaximizingitsgrowth rateasthisgoalwouldanswermanyoftheobjectivesofafirm.Agrowthrateisabetteryardstickto measurethesuccessofafirm.Growthdependsonthevolumeofinvestment.Investmentdepends on capitalavailability. Capital maycomefromeither internal orexternal source. External sourceof capital is costly whereas internalgeneration offunds is economical. Generation of internal capital dependsonprofitmakingcapacityofafirm.Hence,profitmaximizationwouldautomaticallyleadto growthmaximization.Itisforthisreason,Marrispointsoutthatafirmhastomaximizeitsbalanced growthrateoveraperiodoftime. Marrisassumesthattheownershipandcontrolofthefirmisinthehandsoftwogroupsofpeople,ie, ownersandmanagers.Hefurtherpointsoutthatbothofthemhavetwodistinctivegoals.Managers haveautilityfunctioninwhichtheamountofsalary,status,position,power,prestigeandsecurityof jobetcarethemostimportantvariableswhereasincaseofownersaremoreconcernedaboutthe sizeofoutput,volumeofprofits,marketshareandsalesmaximizationetc. Utilityfunctionofthemanagersandthattheownersareexpressedinthefollowingmanner Uo=f[sizeofoutput,marketshare,volumeofprofit,capital,publicesteemetc] Um=f[salaries,power,status,prestige,jobsecurityetc]. InviewofMarristherealizationofthesetwofunctionswoulddependonthesizeofthefirm.Larger thefirm,greaterwouldbetherealizationofthesefunctionsandviceversa.Sizeofthefirmaccording 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 thefirm rather than growth inabsolute size of thefirm. Generally managers like to stay in a growing firm. Higher growth rate of the firm satisfy the promotional opportunitiesofmanagersandalsotheshareholdersastheygetmoredividends.

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Marrisidentifiestwoconstraintsintherateofgrowthofafirm. 1. Thereisalimituptowhichoutputofafirmcanbeincreasedmoreeconomically,limittomanage thefirm efficiently, limit toemploy highly qualified and experienced managers, limit to research anddevelopmentandinnovationetc. 2. Theambitionofjobsecurityputsalimittothegrowthrateofthefirmitselfdeliberately.Ifgrowth 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. Managershesitatetotakeunwantedrisksanduncertaintiesintheorganizationatthecostoftheir jobsTheywouldliketoavoidriskyinvestmentprojects,concentrateongeneratingmoreinternal funds and invest more finance on only those products and services which brings more profits Hence,managerswouldliketoseektheirjobsecuritythroughadoptionofacautiousandprudent financialpolicy. He further points out that a high riskloving management would like to maintain a relatively low amountofcashonhandandinvestmoreonbusiness,borrowmoreexternalfundsandinvestmore in business expansion and keep a low profit levels. On the other hand, a highly riskaverting management may have exactly opposite policy. Ultimately, it is the job security which puts a constraintonbusinessdecisionsbythemanagers. The Marris growth maximization model. highlights on achieving a balanced growth rate of a firm. Maximumgrowthrate[g]isequaltotwoimportantvariables 1. Therateofdemandfortheproducts[gd] 2. 2.Growthrateofcapital[gc] Hence,Maxg=gd=gc. Thegrowthrateofthefirmdependsontwofactorsa]therateofdiversification[d]andb]theaverage profitmargin. Thediversificationratedependsonthenumberofnewproductsintroducedperunitoftimeandthe 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, publicity, propaganda and advertisements, R&D expenses and

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utilityandcomparativevalueoftheproductetcwoulddecidetheprofitratio.Higherexpenditureon salespromotionandR&Dwouldcertainlyreduceprofitslevelastherearelimitstothem. Therateofcapitalgrowthisdeterminedbyeitherissueofnewsharestoobtainadditionalfundsand externalfundsandgenerationofmoreinternalsurplus.Generallyafirmwouldselectthelastoneto avoidhigherdegreesofrisksinthebusiness. TheMarrismodelstatesthatinordertomaximizebalancedgrowthrateorreachequilibriumposition, there should be equality between the growth rate in demand for the products and growth rate in supplyofcapital.Thisimpliesthesatisfactionofthreeconditions. 1. Themanagementhastomaintainalowliquidityratio,ie,liquidasset/totalassets.Butthisratio should not create any financial embarrassment to meet the required payments to all the concernedparties. 2. Themanagementhastomaintainahighratiobetweenadebt/assetsothatitwillhaveenough moneytoinvestinordertostimulategrowth. 3. The management has to keep a high level of retained profits for further expansion and developmentbutitshouldnotdispleasetheshareholderbygivinglowdividends. Inthiscase,themangerswouldmaximizetheirutilityfunctionandtheownerswouldmaximizetheir utilityfunctions.Themanagersareabletogettheirjobsecuritywithahighrateofgrowthofthefirm andshareholderwouldbecomehappyastheygethigheramountofdividends. Demerits 1. It is doubtful whether both managers and owners would maximize their utility functions simultaneouslyalways 2. Theassumptionofconstantpriceandproductioncostsarenotcorrect. 3. Itisdifficulttoachievebothgrowthmaximizationandprofitmaximizationtogether. SelfAssessmentQuestions4 1. According to ____ modern firms are managed by both the manager and the shareholders (owners). 2. In_______,theobjectiveofthefirmisbalancedgrowth. 3. In Marris Growth Maximization Model, the manager tries to maximize his satisfaction and his satisfactionliesinthe______.

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4. In______relationship,growthdeterminesprofit. 6.6.BoumalsStaticAndDynamicModels. Salesmaximizationmodelisanalternativemodelforprofitmaximization.Thismodelisdeveloped 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 maximizationofsalesdoesnotmeanmaximizationofphysicalsalesbutmaximizationoftotalsales revenue.Hence,themanagersaremoreinterestedinmaximizingsalesratherthanprofit.Thebasic philosophyisthatwhensalesaremaximizedautomaticallyprofitsofthecompanywouldalsogoup. Hence, attention isdivertedto increase thesales of thecompany in recent years inthe contextof highlycompetitivemarkets. Indefenseofthismodel,thefollowingargumentsaregiven. 1. Increase in sales and expansion in its market share is a sign of healthy growth of a normal company. 2. Itincreasesthecompetitiveabilityofthefirmandenhancesitsinfluenceinthemarket. 3. Theamountofslackearningsandsalariesofthetopmanagersaredirectlylinkedtoit. 4. Ithelpsinenhancingtheprestigeandreputationoftopmanagement,distributemoredividendsto shareholdersandincreasethewagesofworkersandkeepthemhappy. 5. Thefinancialandotherlendinginstitutionsalwayskeepawatchonthesalesrevenuesofafirm asitisanindicationoffinancialhealthofafirm. 6. Ithelpsthemanagerstopursueapolicyofsteadyperformancewithsatisfactorylevelsofprofits ratherthanspectacularprofitmaximizationoveraperiodoftime.Managersarereluctanttotake up those kinds of projects which yield high level of profits having high degree of risks and uncertainties. The riskaverting and avoiding managers prefer to select those projects which ensuresteadyandsatisfactorylevelsofprofits. Prof, Boumal has developed two models. The first is static model and the second one is the dynamicmodel.

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TheStaticModel Thismodelisbasedonthefollowingassumptions. 1. The model is applicable toaparticular time period and the modeldoesnot operateatdifferent periodsoftime. 2. Thefirmaimsatmaximizingitssalesrevenuesubjecttoaminimumprofitconstraint. 3. Thedemandcurveofthefirmslopedownwardsfromlefttoright. 4. .TheaveragecostcurveofthefirmisUshapedone. With the help of the following diagram, we can explain sales maximization model subjecttoaminimumprofitconstraint.
TC Y TR M Q

TC,TR,PROFIT

OperativeProfit Constraint

s P2 P1 R P 0

L N K P2 P1 NonOperative Profit Constraint P X X1 X2 X3 Output

Profitcurve

AtOX1levelofoutputprofitismaximum,TRismuchinexcessofTC.Ifthefirmchoosestoproduce OX3outputprofitwillfalltoX3KthoughtheTRisstillinexcessofTC.ProfitconstraintislesatOX2 level of output as the firm earns X2 N profit depending upon the market condition a firm can determinethelevelofoutputwithminimumprofitconstraint. Salesmaximization[dynamicmodel] Intherealworldmanychangestakesplacewhichaffectsbusinessdecisionsofafirm.Inorderto include such changes, Boumal has developed another dynamic model. This model explains how

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changes in advertisement expenditure, a major determinant of demand, would affect the sales revenueofafirmunderseverecompetitions.Assumptions 1.Higheradvertisementexpenditurewouldcertainlyincreasesalesrevenueofafirm. 2.Marketpriceremainsconstant. 3.Demandandcostcurvesofthefirmareconventionalinnature. Generally under competitive conditions, a firm in order to increase its volume of sales and sales revenue wouldgofor aggressive advertisements. This leads toa shift inthe.demand curve to the right.Forwardshiftindemandcurveimpliesincreasedadvertisementexpenditureresultinginhigher sales and sales revenue. Aprice 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 increaseitssalesonlywhenthedemandiselasticandifthedemandisinelasticsuchapolicywould 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,salesofthecompanywouldalsogoup.Asalesmaximizerwouldgenerallyincurhigher amountsofadvertisementexpenditurethanaprofitmaximizer.However,itistoberememberedthat amountallottedforsalespromotionshouldbringmorethanproportionateincreaseinsalesandtotal profitsofafirm.Otherwise,itwillhaveanegativeeffectonbusinessdecisions Thus, by introducing, a nonprice 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 differentiatedproducts,wouldresorttoheavyadvertisementsasaneffectivemeanstoincreasetheir salesandsalesrevenue.Thisappearstobemorepracticalinthepresentdaysituations. SelfAssessmentQuestions5

1. Salesmaximizationmodelisanalternativefor____model. 2. Boumalthinksmanagersaremoreinterestedinmaximising___ratherthanprofit. 3. In oligopoly market structure, the firms compete more in terms of advertisement, product
variationsetc.ratherthan____.

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6.7 WilliamsonsManagerialDiscretionaryTheory Prof. O.Williamson has developed a highly useful and most practical managerial utility model to explaingoalsofabusinessfirminrecentyears.Inmanyorganizationswecomeacrossthatwhen once a firm achieves a certain amount of growth, the top mangers concentrate their attention on maximizing their selfinterest and allow the growth rate to continue. Thus, profit maximization and managersutilitymaximizationgotogether. Assumptionsofthemodel 1. Existenceofimperfectmarkets. 2. Ownershipandmanagementisseparated 3. Aminimumlevelofprofitistobeachievedbyafirmtopaydividendstoshareholders. Themodel Williamsonisoftheopinionthatmanagersasapowerfulgroupinanyorganizationhavetheirown set of utility functions. They have certain expectations and demands. Generally they aim at maximizingtheirmanagerialutilityfunctionsratherthanmaximizingtotalprofitsofthecompany.They feelthatafirmismakingprofitonaccountoftheeffortsoftopmanagementandassuchtheyare 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, powerenjoyedbythem,dominance, professionalexcellence, security oftheir jobs, salary and other perquisitesetc. Outof these variables, onlysalary is measurableandall othervariables are nonmeasurable. In order to measure other variables, Williamson introduces the concept of expense preference. This concept helps to measure the level of satisfaction which managers wouldderivefromcertaintypesofexpenditures.ThemanagersutilityfunctionisexpressedasU=f [S,M,Id]Where S=Additionalexpenditureofstaff. M=ManagerialEmoluments Id=Discretionaryinvestment. Thestaffexpenditure[S]includesthewagesandsalariespaidtoadditionalstaffemployedwhohave toworkunderthetopmanagement.Nowmanagerswillhavealargerteamthanbeforeandallotthe 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 professionalexcellencewhichcertainlywouldmotivatetheworkerstoworkmore.

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Managerial emoluments [ M] include expenses on entertainment, luxurious airconditioned office, Costlycompanycarsandotherallowances,giventomanagers.Ithasbeenpointedoutthatthese expensesarejustifiedbymanagersasitwouldenhancetheirstatus,prestige,power,betterworking environmentandimageofthecompanyintheeyesofpublicetc.Thiswouldmotivatethemanagers todotheirworkinacongenialatmosphereandfreemanner. Discretionarypowerofinvestmentexpenditure{Id]includesthoseinvestmentexpenseswhichconfer certain personal benefits and satisfaction to managers. For example, expenditure on latest equipments,furniture,decorationmaterialsetc.Theseexpensesareexpectedtoelevatethestatus andesteemofmanagers.Theysatisfytheiregoandsenseofpride. Thus,alltheseexpendituresaremadebyafirmtokeepthemanagershappyandmotivatethemto workmore.Theabovementionedexpendituresaremeasurableintermsofmoneyandtheycanbe used as proxy variables to replace the nonoperational concepts like power, status, prestige, professionalexcellenceetcappearinginthemanagerialutilityfunction. Itistobenotedthatalltheexpensesareincludedintotalcostofoperationsofafirm. Theprofitsof thecompanyaremeasuredbytakingtintoaccountoftotalexpensesandtotalrevenueearnedbya firm. The difference between the TR and TC would measure the volume of profits. A minimum amountof profits are required to distribute reasonable dividends to share holders. Otherwise, they demandforachangeinmanagement.Thiswouldcreatejobinsecuritytothemanagers.Hencethey canmaximizetheirutilityfunctionsonlywhentheyensurereasonableprofitstoacompany. There is no direct relationship between managers utility function and better performance always. Theempiricalevidenceisnotenoughfortheverificationofthetheory.Alwaysafirmcannotspend more money on only improvements in the working conditions of mangers. It has to look in to the interestsofallgroupsinanorganization. SelfAssessmentQuestions6

1. Theexpenditure,whichisincurredbytheManagersindulgenceinacompanycaristermedby
Williamsonas_____

2. Intheequation U = f( ,D),Sstandsfor____andDstandsfor____. S

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6.8.Summary Units6enlightenusaboutthevariousalternativeobjectivesofafirm.Thetraditionalobjectiveisthat ofprofitmaximization.Butinrecentyears,economistshavedevelopedvariousalternativeobjectives to suit to modern business environment. The theory of firm highlights on wealthmaximization 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 theoryconcentratesonthebehaviorofvariouscoalitionpartnersinanorganizationandexplainhow oppositegoalsofdifferentgroupswouldaffectthedecisionmakingofafirm.Marrismodelanalyses the rate of growth of a firm via maximizing managers powers and status. Boumal analyses the impactofadvertisementexpendituresincurredbyafirmonsalespromotionanditsimpactontotal sales revenue of a firm. Williamson studies the impact of managerial utility functions on the performanceofafirm.Thus,afirmhasseveralalternativegoalsandtheselectionofparticulargoals dependsonthemanagementofafirm.Itistoberememberedthatallotherobjectivesofafirmcan berealizedonlywhenafirmismakingreasonableamountofprofits.Anyorganizationhastoearn adequateprofitstopleasetheshareholders.Inordertomakemoreprofits,afirmhastocreatemore wealth,assets,andsurpluses,satisfytheexpectationsoftopmanagers,workers,andachieveahigh growthrateofthefirm.Allobjectivesareinterconnectedandsupplementoneanother.Realizationof oneobjectivewoulddependonotherobjectives.Hence,thereshouldbeaproperbalancebetween differentobjectives. TerminalQuestions

1. Discussprofitmaximisingmodel. 2. Explaineconomisttheoryoffirms. 3. AnalyseSyerttoMarchsbehavioustheory 4. ExaminetheMarrisgrowthmaximisingmodel. 5. CriticallyexamineBoumalsstaticanddynamicmodels. 6. GiveanaccountofWilliamsonsmanagerialdiscretionarytheory.

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AnswertoSelfAssessmentQuestions SelfAssessmentQuestions1

1. ProfitMaximisationModel 2. BreakEvenpoint 3. TotalRevenue

SelfAssessmentQuestions2

1. Transformation 2. Profitmaximizingoutput 3. Changes

SelfAssessmentQuestions 3

1. Marketsharegoal 2. Profitgoal 3. Slackpayment 4. SequentialhearingtodemandandDecentralizingthedecisionmaking 5. Conflictingandopposite

SelfAssessmentQuestions4

1. RobinMarris 2. MarrisGrowthMaximizationModel 3. Growthrateofthefirm 4. Differentiateddiversification

SelfAssessmentQuestions5

1. Profitmaximization 2. Sales 3. Price

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SelfAssessmentQuestions6

1. Managementslack 2. Staffexpenditureanddiscretionaryprofit
AnswertoTerminalQuestions 1. RefertoUnit6.2 2. RefertoUnit6.3 3. RefertoUnit6.4 4. RefertoUnit6.5 5. RefertoUnit6.6 6. RefertoUnit6.7

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