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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 • • • • • • 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 • • • • • 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 • • • • 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 • • • • 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 • • • • 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.