Alternatives theories of the

firm
 Managerial theories
• Baumol (1962); Marris (1964) and Williamson
(1963) suggest that managers may pursue a
strategy of maximum growth of the firm
• Separaton of Ownership from Control
• Two implications:
– Increasing organizational complexity meant that it
was impossible for the large firms to be managed
solely by the owner
• Teams of managers
• Functional divisions
– Impractical for the enterpreneur to finance solely by
personal resources
• Presence of capital markets
Baumol’s Theory of Sales Revenue
Maximization
• Maximize sales revenue subject to
minimum profit constraint
• Why sales revenue and not profits??
– Sales are good general indicator of
organizational performance
– Executive power, influence, status tend to be
linked to the sales performance
– Lenders tend to rely on sales data
• Profit figures are available only annually
• Maximization of sales is more satisfying
for managers as profits go to the pocket of
shareholders
• Salaries and slack earnings of the top
managers are linked more closely to sales
than profit
• Routine problems can be more easily
handled by growing sales
Figure 3.1 Baumol’s sales revenue maximization model
• Thus there are two types of equilibrium:
One in which profit constraint does not
provide an effective barrier,
And second in which profit constraint does
provide an effective barrier
 Criticism
• It has been argued that in the long run,
baumol’s sale maximisation hypotheses
and the conventional hypothesis will yield
identical results as required level of profit
would concide with normal level of profit
 Marris’s Theory of Growth
Maximization
• Strategy of max. Growth of firm :Max. Growth at
the expense of firms’ future profit streams.
• Marris define growth rate(Gr) as Gr=Gd=Gc
• Managers strive for growth rather than profit
max.
• Growth of demand => advertising expenditures;
further price reductions; extensive
advertisements
• Faced with two types of constraints:
-Managerial constraint on growth
–Financial constraint on growth
• Managerial constraints arise due to:
-Limit to managers’ ability to manage and achieve optimum
efficiency
-managers’ own job security
• Financial constraints arise due to:
- Conflict between managers’ own utility function and
owners utility function
- Um=f(salary, power, job security, status)
- Uo=f(profit, capital, output, market share, public
reputation)
- However he claims that the two utility functions converge
into one variable that study growth in the size of firm.
Figure 3.2 Marris’s growth maximization model
• As the rate of growth of demand is increased,
profitability is increased until a certain point.
Then managerial constraints on growth tend to
take place.
• The maximum growth of capital function shows
the relationship between the firm’s rate of profit
and the maximum rate at which the firm is able
to increase its capital
• This model suggests several testable hypothesis
one of which is: “owner controlled firms achieve
lower growth and higher profits”.
 Williamson’s Theory of Managerial
Utility Maximization
• Baumol’s model view that managers’ interests are tied to
a single variable: sales revenue.
• Williamson (1963) argue that several variables should be
in the manager’s utility functrion
• U=U(S,M,ProfitD)
U= Utility function
S= Expenditure on staff (which leads to a higher prestige
on behalf of the manager)
M= Expenditure on managerial banefits (company car,
fringe benefits, ..)
ProfitD= Net profit (after tax and expenditure over and
above the minimum level of profit required
 Assumptions
• Demand function: Q=f(P,S,e)
• Cost function :C=f(Q)
• Profit measures
Actual profit=R-C-S
Reported profit= Actual Profit- Managerial
emoluments
Minimum profit = Actual Profit- tax
Minimum profit + tax< or= reported profit
Discretionary profit=Actual profit=minimum profit +
tax
Figure 3.3 Williamson’s managerial utility maximization model
 The Behavioral Theory of the Frm
• Cyert and March (1964)
• Defines the firm in terms of its
organizational structure and decision
making processes
• Boundaries of the firm are loosely defined
• Satisficing behavior
• Due to observance of actual behavior
within organizations
Figure 3.4 Unitary or U-form organizational structure
Figure 3.5 Multidivisional or M-form organizational structure
 Steps
• Aspiration levels and process of goal formulation
Cyert & March argue that Managers have a
crucial task in formulating a goal for the firm that
reconciles the conflicting and competing
interests of different groups.
• Setting the Goals- The satisficing behavior. Five
types of goals are set: Production goal,
Inventory goal, Sales goal, Market share goal &
Profit goal.
• Production goal: continuity in production irrespective of
any seasonal variability
• Inventory goal : aims at maintaining a balanced inventory
of both raw material and finished goods
• Sales and market share goals aims at promotion and
enhancing the market share of the firm
• Profit goal is so determined that it satisfies the
shareholders, bankers etc.
Note:does not analyse and reveal how a firm reaches its
equilbrium level in satisficing behaviour.