Objectives Of Firms

OBJECTIVES OF BUSINESS FIRMS

 what is an organisation? “An organisation is a consciously coordinated social unit composed of two or more ‘people’ ,that function on a relatively continuous basis to achieve a common goal or set of goals.” “ There is no reason to believe that all businessmen pursue the same objective.” – Baumol

 Profit as an objective of firm “The word profit has different meaning to businessmen, accountants, tax collectors, workers..” - Joel Dean  Accounting profit Vs Economic profit  Theories of profit - Walker’s theory of profit – as rent of ability

- Clark’s dynamic theory ‘ profit is an elusive sum which entrepreneurs grasp but cannot hold. It slips through their fingers and bestows

- Hawley’s risk theory – Residual theory of profit - Knight’s theory of profit – Risk & Uncertainty (A) Risk: A low probability of an expected outcome (in common) From business decision making point of view, risk refers to a situation in which a business decision is expected to yield more than one outcome and the probability of each outcome is known to the decision maker and can be reliably estimated. (B) Uncertainty: It refers to a situation in which there are more than one outcome of a business decision and the probability of no outcome is known or can be meaningfully estimated. Due to – Lack of Reliable market information

- Schumpeter’s innovation theory of profit - Monopoly profit  Problems in profit measurement - Which profit concept to be used? - What costs should be & what costs should not be included? > Depreciation > Capital gains & losses > Current Vs Historical costs – Assets; specially inventory –

 Profit Maximisation as an objective of firm - It has never been unambiguously disapproved. - No alternative hypothesis explains & predicts the behaviour of the firms better than this theory.  Conditions for maximising profit

- Necessary / first order condition: MR = MC

- Secondary / second order condition: The necessary condition

 The defence of profit maximisation: - Profit is indispensable for firm’s survival - Other objectives’ success is dependent on firm’s ability to make profit - It has got a great predictive power - Profit is a more reliable measure of firm’s efficiency - Evidence against this objective are

 Controversy over profit maximisation: - Separation of ownership & management - Assumption of full knowledge of the market conditions on the part of firm is questionable.

 Alternative objectives of firms

 B-G-M Hypothesis - Owner controlled firms have higher profit rates than the manager controlled firms. - The managers have no incentives for profit maximisation.

 Baumol’s Hypothesis of sales revenue maximisation Managers pursue those goals which furthers their interest. - Salary & other management emoluments are more closely related to sales revenue than to profit. - Banks & other financial institutions look at sales revenue for credibility. - Sales revenue trend is more readily available indicator of the firm’s performance - Managers find it difficult to maximise the

 Marris’s Hypothesis of firm’s growth rate maximisation “Managers try to maximise firm’s balanced growth rate subject to managerial & financial constraints.”Robin Marris G = G D = GC GD = Growth rate of demand for firm’s product GC= Growth rate of capital supply to the

 Williamson's Hypothesis of maximisation of managerial utility ‘ Managers seek to maximise their own utility function.’ U = f (S, M, ID ) S = Additional expenditure on staff M = Managerial Emoluments ID = Discretionary investment

 Cyert - March Hypothesis of satisficing behaviour (Simon’s Hypothesis) ‘ A firm is a coalition of different groups

 Rothschild’s Hypothesis of long run survival & market share goals ‘ The primary goal of a firm is long run survival.’  Entry prevention & Risk avoidance Hypothesis Motive : a) profit maximisation in the long run b) Securing a constant market share c) Avoiding the risk caused by

A reasonable profit target Why reasonable profit? a) Preventing entry of new firms b) Projecting a favourable public image c) Restraining trade union demands d) Maintaining customer goodwill e) Managerial utility function is more preferable to profit maximisation etc.

 Standards of reasonable profit - Forms of profit standards a) Aggregate money terms b) Percentage of sales c) Percentage of ROI - How much profit is reasonable? Standards a) Capital attracting standard b) ‘ Plough back’ standard c) Normal earning standards