Download 3.3.1 The objectives of firms

3.3.1 THE OBJECTIVES
OF FIRMS
Its all about control!
The question of what motivates a firm in its actions
is determined by a firm’s stakeholders.
• Owners or shareholders – For a small business it is
clear who makes all of the decisions, however, it is less
obvious in a large business with a large number of
shareholders.
• Directors & managers – Shareholders in a PLC elect
directors to look after their interests. Directors in turn appoint
managers who are responsible for the day to day running of the
business (1)
• The workers – particularly through trade unions may be
able to exert strong pressure on a company (2)
• The state – Underlying legal framework for the operation of the
company. (3)
• The consumer – various associations such as the
consumers association can bring significant pressure on
companies to change their policies (4)
Short run profit maximisation
• Neo Classical economics assumes that the interests of
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owners or shareholders are the most important. (1)
Neo classical economics assumes that is the short-run
profits that firms maximise.
They associate marginal cost and marginal revenue in the
short term to decide upon their level of production.
In markets where there is heavy branding, prices are likely to
be stable.
In commodities markets where firms are producing
homogenous goods such as copper or paper prices are likely
to be unstable.
Short run profit maximisation assumes that a firm will be
prepared to supply even if they make a loss in the short run
as long as the price is above the variable cost of production.
In the long run firms must cover all of these costs or they will
be forced out of the market.
Long run profit maximisation
• Neo Keynesian economists believe that firms
maximise their long run profit rather than their short
term profit.
• This is based upon the belief that firms use cost plus
pricing.
• The price of a product is worked out by calculating the
average total costs of operating at full capacity and then
adding a profit mark up.
• The price set and therefore the profit aimed for, is based
upon the long run cost of the firm.
• Short run profit maximization implies that firms will adjust
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both price and output in response to changes in market
conditions.
According to neo-Keynesians, rapid price adjustments may
damage the firm’s position in a market. Consumers dislike
frequent price changes.
Price cuts may be seen as a sign of distress selling and large
buyers may respond by trying to negotiate larger price
reductions.
Price increases may be seen as profiteering with customers
switching to other brands that they feel may be better value for
money.
Price changes also cost the firm in terms of re-pricing products
and printing new price lists.
Therefore it could be argued that firms aim to maintain stable
prices whilst adjusting to changes in market conditions.
• A firm may therefore produce in the short term even if it
fails to cover the variable cost.
• If a firm feels that in the long run it will make a profit on a
product it may choose to produce at a loss rather than
disrupt supplies to the market.
• Equally it may cease to produce in the short run even if it
can cover its variable costs.
• It may prefer to to keep prices above the market price in
the short run and sell nothing if it believes that price
cutting in the short run would lead to a permanent effect
on prices and therefore profits in the long run.
3.3.1 Q1
Managerial theories
• Assumes divorce of ownership & control.
• Shareholders are assumed to be different from the
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managers.
Shareholders wish to maximise profits.
As workers, managers will wish to maximise their own
rewards including pay and fringe benefits rather than
maximizing profits.
Managers however, have to be seen to be worthy of their
pay.
There is always the threat of takeover or bankruptcy
leading to a loss of jobs. Managers need to make enough
profit to satisfy the demands of their shareholders
PROFIT SATISFICING.
William Baumol
• Theory 1950s
• Firms would attempt to maximise sales revenue rather
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than profit.
The size of a firm can be measured in several ways but in
general they are not compared according to profit.
Instead firms tend to be compared according to the value
of assets, stock, market value or sales revenue.
The larger the size of the firm the higher is likely to be the
pay of senior managers.
Therefore if management rather then owners are in
charge of day to day decisions maximizing sales revenue
might be the main objective of the firm.
• Particularly if sales can be increased at the same average
price as previous sales.
• If this is the case then maximizing sales and maximizing
sales revenue are the same.
O. Williamson
• Managers have a utility function consisting of factors such
as salary, size of the workforce directed by the manager,
the amount of money under his or her control and the
number of perks such as company cars that the manager
receives.
3.3.1 Q2
Behavioral theories
• Herbert Simon
• Decision making within a company is not done by one
group but by all groups involved in the firm.
• It is only by studying the relative power of each group and
the power structures within the organization that the way
in which a firm behaves can be understood.
• 1960s/70s trade unions were very powerful in large
companies. They were influential in increasing the share
of revenue allocated to wages and reducing the share that
went to shareholders.
• During the 1980s/90s government legislation and mass
unemployment weakened the power of the unions .
• At the same time, shareholders became more conscious
of their right to make profits.
• The result was a large increase in the returns to
shareholders which could be seen as being financed by a
reduction in the returns to the workers of the firm.
• Shareholders are more important today in company board
rooms and workers less important than they were 20
years ago.
• Behavioral theories assume that each group has a
minimum level of demands.
• Shareholders demand that the firm makes a satisfactory
level of profits.
• The government demands that laws be obeyed and taxes
paid.
• Workers will require a minimum level of pay and work
satisfaction if they are to stay with the company.
• Consumers demand a minimum level of quality for the
price they pay for goods.
• Local environmentalists may be able to exert enough
moral pressure on the company to prevent gross overpollution.
3.3.1 Q3
Other goals
• Some firms clearly have other aims apart from those
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discussed here.
Consumer cooperatives aim to help consumers.
Worker cooperatives are often motivated by a desire to
maintain jobs or produce particular products such as
health foods.
There have been examples of philanthropic owners in the
past who are not motivated by profit but by social reform
and positive change, Joseph Rowntree for example.
Nationalized industries in the UK prior to 1979 had a
whole range of goals from avoiding a loss to maintaining
employment to providing a high quality service.
Other goals
• It is too simplistic to argue that all firms aim to maximise
profit.
• However there is much evidence to support the view that
large firms whose shares are freely available on the stock
exchange and which are vulnerable to take over bids
place the making of profit very highly on their list of
priorities.
• It is not unreasonable to make the assumption that in
general firms are profit maximizers.