ALTERNATIVE OBJECTIVES OF THE

FIRM
OVERVIEW
 Managerial theories of the firm (non-profit maximizing
objective flowing from separation between ownership &
management)
 There are several models, but mainly concentrating on:
 Baumol’s constrained sales maximization model

 Marris’ maximization of managerial utility model

 Behavioral theories of the firm (firm looked upon as a

Satisficer rather than a Maximizer)
 Cyert and March
CONSTRAINED SALES MAXIMIZATION
MODEL (BAUMOL)
 Managers maximize sales revenue subject to
earning a minimum acceptable level of profit
 Minimum level of profit determined by need to be
able to raise finance to pay for future sales
expansion
 Managers’ salaries more closely linked to sales than
profits, so managers seek to maximize sales
 Larger the firm, easier to raise capital at low rates of
interest
 Large sales encourage bandwagon effect and
retains distributors
CONSTRAINED SALES MAXIMIZATION
MODEL (BAUMOL)
EXTENSION OF CONSTRAINED SALES
MAXIMIZATION MODEL (BAUMOL)

 Extension of model
 The firm’s objective is the maximization of long-run sales
revenue
 Firms may use the profits in excess of the required minimum to
influence the demand conditions through marketing investment
and product development.
 Outward shift in demand curve – sales increase for any
given price level
 Assuming that any expenditure on advertising etc. increases
sales, long run sales maximization requires that all profit in
excess of the minimum be deployed in affecting demand
 Then, long run sales maximization always leads to the profit
constraint being operative
EXTENSION OF CONSTRAINED SALES
MAXIMIZATION MODEL (BAUMOL)
Which point will be chosen under four ∏ constraints
Sales, Cost, Profit

Total cost

∏4
∏3
∏2
∏1
Profit curve
Sales curve

A:∏-max B:Sales max

C:∏=0 Q
MAXIMIZATION OF MANAGERIAL
UTILITY MODEL (MARRIS)
 Decisions on levels of investment and dividend
payments taken by top level management
 Top management maximizes a utility function with two
arguments: long run sustainable growth of sales (desire
for higher salary, power, and prestige) and job security
(avoiding takeovers)
 Tradeoff between growth and security:
 High growth – higher interest charges from more borrowing (thus
increased costs) and increased proportion of retained profits
(thus lower dividend rates) – leads to threat of takeover and job
loss
 Excessive concern for job security (i.e. preference for high rate of
profit) – minimize reliance on borrowed funds – slower growth in
sales (lower salary, prestige etc.)
CYERT & MARCH’S BEHAVIORAL
THEORY OF THE FIRM
 Firm’s objective: To achieve satisfactory values
of profits, sales, managerial benefits, etc.
rather than maximum values of these variables
 Two important characteristics:
 Firm is subject to bounded rationality i.e. its
behavior is intendedly rational but limitedly so due to
informational problems
 The firm attempts to satisfy the goals/aspirations
levels of different interest groups in terms of these
variables