1. Profit maximization2. Sales revenue maximization3. Williamson’s managerial utility model4. Behavioural models5. Corporate social responsibility

Traditional objective of owner-controlled firms. The “building block” of neoclassical economics (not only for theory of firm but also theories of price, and competitive markets)Assumption:

Firm produces and sells single productFirms is managed by its owners. Where there is divorce between ownership and control then the managers still maximize profits on behalf of the owners.

The rules of profit maximization: Firm should produces at the output which maximize its profit, which is output

Revenue – Cost =maxTR – TC = max

Revenue – cost = maxwhere:

Marginal revenue = marginal costMR = MC

Criticisms of profit maximization:Based on the major assumption of neoclassical economics: perfect information and rational decision maker -> not happen in real worldProfit concept relates to time. The theory doesn’t mention about long-run or short-run profit and therefore could not explain the behavior of firm in many cases Doesn’t take into account the complexity of the modern organization structure. Empirical studies also shown that profit maximization is not the single objective of firm (only 26.1% of firms observed in 1981)

Defense of profit maximization:Profit maximization remains an importantassumption in economic analysis partly because itallows precise and predictive analysis of decisionsof firmsEmpirical studies still show profit maximizationremains an importance objective of firms.

Reasons:Sales revenue is a more useful short-term goal for the firm than profit. Sales are measurable and can be used as a specific target to motivate staff. Increase in revenue will more than offset any associated increases in costs -> Sales revenue increase = profit increaseIncreasing sales hence the size of the firm make it easier to manage.

1. How does the price – output combination differ between a sales and profit-maximizing firm?

2. How will managers react to the following changes in costs if they are profit maximizers, on the one hand, and sales maximizers, on the other:

1. An increase in fixed costs? 2. An increase in variable costs?

Assumption of the model:There are divorce between ownership and controlSenior management seeks to maximize its own utility function rather than that of the owner.

Content: Benefits related to management including

Salary :directly measurable in monetary termsNon-pecuniary benefits: related to expenditures on:

StaffFringe benefits (free car, luxurious office, etc)Discretionary investment

The satisfaction for management increase costs for firm (directly and indirectly)

Comparison between Profit maximization & Utility:Profit maximization model:

RP = AP = MP +DPManagerial utility model:

RP = MP +DP – DE (with AP>MP)whereas:• MP: minimum profit• AP: Actual profit• RP: Reported profit• DP: Discretionary profit• DE: Discretionary expenditure

Discretionary profit

Discretionary expenditure

1

2

S1 S2

AssumptionDivorce between ownership and controlInternal structure of firm and the interaction between groups could influence the firm’s objectives.

Contents:Analyze the process by which firms decide on their objectivesAnalyze the objectives setting, achieving and adjusting

2. Evaluate performance

5. Aspiration level rises

Decision making process

There are groups/ department of conflict interestsThe above groups all have their influences to the sets of objectives of the firmThe agreed objectives are satisfied to all above groups. Identify the objectives that need to be set, those in turn will guide the decision making process in individual department/ section

Some specific objectivesProduction objectiveStock objectiveSales objectiveMarket share objectiveProfit objective

Process to reach agreement:Negotiate among groups by paying additional money or more resources allocated to groups or individuals to make them content with the objective chosen by the firm. Making side payment or policy commitments to keep groups or individuals happy with any agreement. Once objectives are agreed, decision will be made for achieving objectives (such as price, advertising…)

Criticisms of the behavioural theory:Only adopt a rather short-term vision of what the firm is trying to achieve.The theory does not explain the behaviour of firms nor does it predict how actual firm react to changes in the external environment. The theory does not consider the behaviour of other firms.

Divide into 6 different groups:Owners/ Investors of the companyFinance departmentSales department Marketing departmentInventory departmentProduction department

The company produces and sells table computers. As the economy is going down and other reasons, sales revenue did not achieve the target.

“Customers might want better PC with new technology where the firm is not able to adopt”, according to sales

Inventory is full of “out-dated” stocks which according to sales are obsolete.

Production department still insist on manufacturing rather than cutting employees, saying that the current products are marketable, just sales dept are not working hard enough

Owners of the company want to have normal profit as before, which not been achieve d for the last 3 quarters.

Definition: the extent to which individual firms serve social needs rather than those of owners and managers, even if this conflicts with the maximization of profits (Moir 2001)The firm might:

Internalize social goalsRepresent concerns of groups other than owners and managersUndertake voluntary action beyond that required by lawRecognize the social consequences of economic activity.

Examples of expenditures on social responsibility might include:

Charitable giving.Seconding staff to help with the management of community projects.Sponsorship of arts and sports, though at some point such expenditure might be regarded as advertising. And behaving in an environmentally responsible way by not polluting rivers, etc.

Benefits for firm taking social responsibilities:Long-run self-interest of the firm: socially responsible behaviour generates additional revenue and profits in the long run compared with firms that are less socially responsible; this has been termed ‘‘winning by integrity’’.Stakeholders: it is beneficial to the firm to keep in line with ethical, social and cultural norms, because this keeps workers, customers and suppliers happy and minimizes the risks to the reputation and profitability of the firm.Regulation: bad corporate behaviour may lead to the imposition of an expensive and inflexible regulatory regime to curb antisocial behaviour, while good corporate behaviour may lead to the avoidance of government regulation and be a more beneficial outcome for the firm

1. Do you think “Bags of luck” likely to be an owner-controlled or managerial-controlled firm? Explain your reasons2. Can you identify the objective (s) of Bags of luck? Do you think all members of the firm have the same set of objectives?3. Provide 3 solutions to help resolve the difficulties facing Bags of luck. Ranking the importance of those solutions