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OPEN ACCESS
Manuscript ID:
MGT-2021-08043816
Volume: 8
Issue: 4
Month: April
Year: 2021
P-ISSN: 2321-4643
E-ISSN: 2581-9402
Received: 29.01.2021
Accepted: 03.03.2021
Published: 01.04.2021
Citation:
Kumar, B. Pradeep.
“Changing Objectives
of Firms and Managerial
Preferences: A
Review of Models in
Microeconomics.” Shanlax
International Journal of
Management, vol. 8, no. 4,
2021, pp. 43-46.
DOI:
https://doi.org/10.34293/
management.v8i4.3816
This work is licensed
under a Creative Commons
Attribution-ShareAlike 4.0
International License.
Changing Objectives of Firms and
Managerial Preferences: A Review of
Models in Microeconomics
B. Pradeep Kumar
Assistant Professor of Economics, Government Arts & Science College, Ambalapuzha, Kerala &
Research Supervisor, University of Kerala, Thiruvananthapuram, India
https://orcid.org/0000-0003-4232-9640
Abstract
Theoretically, producer behavior models postulate that rms have had different objectives
ranging from prot maximization to setting aspirational levels. The assumption of the objective of
prot maximization was shaped based on the rationality principles, which has lost relevance with
the coming of the principle of behavioral economics in recent time. The present paper intends to
throw some light on changes that have been made in the objective of rms over years and attempts
to review some models emphasizing managerial utility as the core objective of rms.
Keywords: Prot maximization, Sales maximization, Managerial utility function,
Managerial discretionary powers, Slacks and salaries, Behavioral economics
Literature in microeconomics has a treasure of descriptions regarding the
dominant objectives that the rms have had to pursue. In the beginning, it
was thought that the rms had been pursuing and had been expected to pursue
only one objective, that is, the maximization of prot. This assumption of the
objective of prot maximization was shaped based on rationality principles.
Based on rationality, it was supposed that economic agents, being rational,
have had to pursue either the goal of utility satisfaction (for consumers) and
prot maximization (for producers). Following this, in early times, producer
behavioral theories and models in economics emphasized prot maximization
as the sole objective of rms. Since then, many shifts have been made in
the considerations of the objectives of rms, thanks mainly to the changes
in the organization of rms. The objectives of sales maximization, revenue
maximization, and managerial satisfaction (popularly known as the managerial
utility function) are some of such changes or shifts in the objective of the
rms. Among these, the most recent and the important one is the principle of
the managerial utility function, which postulates that rms attempt to increase
managerial satisfaction as a proxy for many of their other important functions,
including the objective prot maximization. The tendency of offering high
compensation packages for managers by the corporates stands testimony to
the increasing attention on the part of the rms to focus much on the managers
in an attempt to materialize the corporate objectives. The present paper
intends to throw some light on changes that have been made in the objective of
rms over years and attempts to review some models emphasizing managerial
utility as the core objective of rms.
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Prot Maximization - the Early Sole Objective of
Firms
Prot maximization has been hypothesized as
the rational behavior of a rm. Every rm attempts
to maximize prot given the cost and market
conditions. The marginalist school in economics
gave sufcient theoretical underpinnings to the
objective of prot maximization. The economic
theory uses two methods to explain the conditionality
for the maximization of prot: One is the famous
and direct Total Cost-Total Revenue Concept. The
other is the Marginal Cost and Marginal Revenue
method. Thanks to the popularity that marginalism
has assumed in the eld of economics it quite natural
that the latter method has received wide currency in
the realm of economic literature. The elucidation of
the rms’ behavior in different market models like
perfect completion and monopoly centers around the
argument that the rms continue to produce when
the prot gets maximized, the so-called equilibrium
point. All rms, irrespective of market conditions,
are supposed to behave rationally, and therefore,
each one of them would be endeavoring to attain
maximum prot. Although this could be considered
as a starting point of the behavior of rms, this could
not be regarded as the single objective with which all
rms are expected to have been working.
The main lacuna of this argument is that it does
not consider the effect of time, specically the time
value of money. Some rms under the real market
conditions may act in such a way that they give up
prots to withstand in the market, hoping that in
the long run, they would be able to reap the prot.
The infamous strategy of selling products at a price
less than the average cost by rms in an attempt to
capture the market goes diametrically opposite to the
prot maximization strategy of the rms. In the short
turn, rms are seemed to be giving up their prot
for a high prot in the long run. This time element
in the prot expectation of rms does not nd any
place in the prot maximization principle based on
the rational economic behavior as postulated by the
so-called marginalist school in economics. Another
point of weakness of this argument lies in the absolute
negligence that it shows towards the uncertainty and
risks involved in planning the activities of rms.
Nevertheless, in the case of which ownership and
control rest on the same hand, prot maximization
may continue to be the sole objective. It is not
surprising that in small rms and businesses even
today, prot is the sole objective. Some economists
opine that the objective of prot maximization is just
an assumption (Mert, 2018)
Shareholders and Managers
The organizational changes in the structure of
companies made a clear-cut divide between the
managers and the shareholders or the exact owners
of the rms. The corporatization of business entities
fuelled this trend and triggered the difference
between the objectives of managers and the
shareholders. While in the earlier system of owners
acting themselves as the managers, the objective of
prot maximization had an important place. But in
later times, with the coming up market capitalization
of business entities, the objective of the ultimate
owners or the shareholders of the company became
different from that of the managers. Although the
shareholders wanted to have reasonably maximum
prot from the business, the managers paid much
attention to enhancing their salaries, perks, and other
career opportunities. Shareholders did not have
much information about the business. Therefore,
they could not exercise unlimited inuence on the
managers to pursue them to fall in line with the
objective of maximizing prots.
Sales Maximization, not Prot Maximization
Managers appear to be more concerned with
increasing the company’s sales to keep the company
as a market leader. The prestige of the manager
does not depend on maximizing the prot but on
the size of the market and the volume of business
that they command. Taking this into account Prof.
Baumol, opined that rms’ main objective is not to
raise the level of prot but to raise the sales of the
company after having attained a certain desirable
limit of prot. In the view of Baumol, after an
acceptable level of prot is reached, the emphasis
of the rm will be shifted from prot maximization
to sales maximization. Baumol argues that given
the separation of ownership from management and
changing the organizational structure of rms, the
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shift to the objective of sales maximization has been
quite evident. Since managers’ salaries and slacks
(slacks are what managers receive over and above
what is required to maintain them in the company.
It is similar to ‘economic rent’ in traditional theory
(Koutsoyiannis, 1979)) is more aligned with the
volume of sales, not with the prot of the rms,
it quite natural that managers would be focusing
more on sales maximization rather than the prot
maximization (Baumol, 1959).
Satiscing Behavior of Firms
In rms with dichotomization of the ownership
and control of the entity, prot satiscing has been
considered to be an important objective. Here,
managers of the rms are expected to prot from the
business, making shareholders or the owners of rms
happy. After making that satiscing prot, another
objective that meets the aspirations of the managers
would be followed. The difference between the
production behavior aiming for prot maximization
and prot satiscing can be understood from the
following gure. The X-axis measures the quantity
of output and Y-axis prots. Two prot levels are
shown viz.’ π
max
,’ maximum prot level and ‘π,’
satisfying prot. A prot-maximizing rm would
choose to produce ‘q
p
’ quantity of output while a prot
satiscing might produce any quantity between ‘q
o
’
and ‘q
s
’ (https://www.economicsdiscussion.net/rm,
2021). The principle-agent problem would occur in
these cases. Managers being the agents, possess all
information about the rms. Therefore, they attempt
to capitalize on the information asymmetry and try
to pursue their own goals instead of focusing on
enhancing the level of prot after a certain limit.
Figure 1: Alternative Objectives of Firms: Prot
Satiscing Behavior of Firms
Source: https://www.economicsdiscussion.net/rm
Marris’s Managerial Utility Function
In Marris’s model of Managerial Enterprise,
Marris stresses the importance of managerial utility
function in accomplishing the goal of a rm, the
maximization of the balanced rate growth of the rm
(Marris R., 1963). In pursuing this goal, the rm has
two main constraints: the availability of managerial
team and skill and a nancial constraint (Marris R.,
1964). The utility function of the managers may be
written as:
U
M
= f (salaries, power, status, job security)
In the utility function of the managers, as outlined
above, salaries occupy an important place along with
other elements like power, status, and job security.
Putting it differently, the managerial utility function
is nothing but a function of the compensation to
managers plus some other quality variables like job
security and status. In pursuance of this, rms have
been offering high salaries and job security to top-
level managers to prompt promising managers to
continue in the job and concentrate on furthering the
designed objectives of rms, including maximization
of revenue, sales, and prots.
Williamson’s Model of Managerial Discretion
It is well known that in the emerging business
environment and the changing organizational
structure of enterprises, managers enjoy certain
discretionary powers in running the business not
only in the interest of owners or shareholders
but also, more importantly, in the interest of the
managers themselves. These discretionary powers
have been modeled rst by O. Williamson in 1963
(Williamson, 1963). It is argued that managers have
full discretion in pursuing their own goals and not the
owners’ objective of maximizing the prot. Making
or maximizing prot is regarded as something which
acts as a hindrance to the behavior of the managers.
But, they need to take care of the prot in the absence
of which their job security would be endangered. As
in Marris’s model here also the managerial utility
function encompasses variables like salary, security,
power, status, prestige, professional excellence, and
the like. It is obvious that of these variables, only
the rst one can be made amenable to measurement.
The others variable are together labeled as expense
preference, ‘which is dened as the satisfaction which
managers derive from certain types of expenditures’
(Koutsoyiannis, 1979).
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Concluding Observations
Thus, it is quite evident that the tendency of
offering high compensation packages for managers
by the corporates stands testimony to the increasing
attention on the part of the rms to focus much on the
managers in an attempt to materialize the corporate
objectives. This paper has thrown some light on
changes that have been made in the objective of
rms over years and attempts to review some models
emphasizing managerial utility as the core objective
of rms. As evident from the review of models,
one can comprehend the importance attached to the
maximization of the managerial utility function these
days as the prominent objective of rms.
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Author Details
Dr. B. Pradeep Kumar,
Assistant Professor of Economics, Government Arts & Science College, Ambalapuzha,
Kerala & Research Supervisor, University of Kerala, Thiruvananthapuram, India, Email ID: [email protected]
