Managerial Theories of Firms.pptx Me

8/10/2019 Managerial Theories of Firms.pptx Me

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Managerial theories of firms The managerial theories separate ownership from

management, the owners are the shareholders, whosepower lies in appointing the board of directors, which inturn appoints top management.

Ownersshareholders

Board of directors TopManagement


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The managers discretion in defining the goals of the firm is limited bythe need to produce a minimum level of profit necessary to satisfy theshareholders.

The basic feature of all managerial theories is that the managermaximize their own utility, subject to a minimum profit constraintnecessary for the job security agent problem

To deal with the principal agent problem(i.e., different goals ofmanager and owners), firms often give managers a financial stake in

the success of the firm so that they pursue objectives that are close toprofit maximization.

Many corporations have adopted employee stock option plan(ESOPs)under which managers can purchase shares of common stock at lessthan market price.


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These plan give managers an incentive to promote profits of the firmand to act in harmony with the interests of the owners.

One recent study shows that if managers own between 5 and 20 per

cent of a firm, the firm is likely to perform better in terms ofprofitability, than they own less than 5 per cent.

In the USA, there are approximately 10,000 ESOPs with 10 millionemployee owners(ESOP Association, USA).

Wipro and Infosys, the two largest listed IT Stock in India, were

amongst the first companies to institute ESOPs.


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Assumption

1. There is a single period time horizon of the firm.

2. The firm aims at maximizing its total sales revenue in the long runsubject to a profit constraint.

3. The firms minimum profit constraint is set competitively in terms ofthe current market value of its shares.

4. The firm is oligopolistic whose cost curves are U- shaped and thedemand curve is downward slopping.its total cost and revenue curvesare also of the conventional type.

5. Advertisment is a major instrument of the firm as non-pricecompetition is the typical form of competition in oligopolisticmarkets.

6. Production costs are independent of advertising

7. Price of the product is assumed as constant


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The Factor which explain the pursuance of sales goals by themanagers are following.

First, salary and other earnings of managers are more closely related to

sales revenue than profits Second,banks and financial corporations look at sales revenue while

financing the corporation

Third, trend in sale revenue is a readily available indicator of theperformance of the firm. It helps also in handling the personnel

problem. Fourth, Increasing sales revenue enhances the prestige of managers

while profits go to the owners.


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FIFTH, managers find profit maximization a difficult objective tofulfill consistently over time and at a same level. Profits may fluctuate

with changing conditions.

Sixth, growing sales strengthen competitive spirit of the firm in themarket and vice versa.

The implication of Baumols model is that risk avoidance has a

statistical effect upon economic activities, e.g. R&D in large firms.


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Sales Maximization Model

(Baumol)


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So far as empirical validity of sales revenue maximization objective isconcerned, factual evidences are inconclusive. Most empirical worksare, in fact based on inadequate data simply because requisite data ismostly not available. Even theoretically, if total cost function intersectsthe total revenue functions(TR) functions before it reaches its climax,Baumols theory collapses.


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Criticism of BaumolsModel

1. Rosenberg has shown that it is difficult to specify exactly the relevantprofit constraint for a firm.

2. Hawkins has also shown that baumols conclusion that a sales-maximiser will in general produce and advertise more than a profit-

maximizer,is invalid3. In the case of multi-products,Baumol has argued that revenues and

profit maximization yield the same results. But Williamson hasshown that sales maximization yields different result from profitmaximization

4. Another weakness of this model is that it ignores theinterdependence of the prices of oligopolistic firms.

5. The model fails to explain observed market situations in which priceare kept for considerable time periods in the range of inelasticdemand.


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6. The model ignores not only actual competition, but also the threat ofpotential competition from rival oligopolistic firms.

7. The model does not show how equilibrium in an industry, in which allfirms are sales maximizes, will be attained. Baumol does not establish

the

relationship between the firm and industry.

8. Professor hall in his analysis of 500 firms came to the conclusion thatfirms do not operate in accordance with the objective of salesmaximization.


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Marriss hypothesis According to robin marris, managers maximize firms balanced growth

rate subject to managerial and financial constraints

The firms balanced growth rate(G) is defined as

In this executive actions are limited by the need for management toprotect itself from dismissal or takeover raids in events of failure

maximize G =GD = Gc

Where GD = Growth rate of demands for firms product and GC=Growthrate of capital supply to the firm.

A firms growth rate is balanced when demand for its product andsupply of capital

to its firm increase at the same rate. The two growth rates areaccording to marris,translated into two utility functions:1) managers

utility function and 2) owners utility function


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The managersutility function(Um) and owner's Utility function( Uo) maybe specified as follows.

Um=f(salary,power,job security,prestige,status)

Uo =f(output,capital,market-share,profit,public esteem)

Model highlights two important factors as far as management isconcerned: the attitude to risk and uncertainty and the desire for utility

which may not be maximised by the pursuit of maximum profits.

Owners utility function may be written as

U0 = f *(gc)

where gc= rate of growth of capital.


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s can be measured by a weighted average of three ratios: the liquidity ratio, theleverage debt ratio and the profit-retention ratio.

1. Liquidity ratio = Liquid assets/Total assets

2. Debt ratio =Value of debt/

Total assets

3. Retention ratio =Retained profits/

Total profits


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Too low liquidity ratio may lead to insolvency and bankruptcy and there is athreat of take-over in case it being too high.

Too low Retention ratio may upset shareholders and too high ratio may inhibit

growth.


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Criticism of marris hypothesis

1. Marris assumes a given price structure for the firms.he therefore, does not

explain how prices of products determined in the market.this is a seriousweakness of his model

2. Another defect of this model is that it ignores the problem of oligopolisticinterdependence of firms in non-collusive market.

3. This model also does not analyse interdependence created by non-pricecompetition.

4. The model assumes that firms can grow continously by creating newproducts. This unrealistic because no firm can sell anything to theconsumers.After all,consumers have their preferences for certain brandswhich also change when new products enter the market.


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Behavioral Theories of the firm Behavioral theories combine industrial economics and organisational

theory.

Unlike managerial theories,behavioural theories view the firm as

engaged in non- maximizing behavior. According to behavioral theories, the firms sub-optimal behavior arises

from uncertainty and conflicting goals of various groups within thefirm

Behavioral theory analyse the organization of the firm,the way in which

decisions are reached,and the inter-group conflicts within theorganization.

Thus while managerial theories emphasize the role of management,thebehavioural theories argue tahat groups within the firm other thanmanagers influence the behavioue of the firm.


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Cyert and march model The theory focuses on the way of decisions are made in the modern large multi

product firm under certainity in an imperfect market

They base their theory on the internal structure of such firms and to analyze

the typical organizational problems which the internal structure of such firmscreates and the effects of these problems on the decision making process.

Cyert and march(1963)makes four major research commitments:

1. To focus on the small number of key economic decision made by the firm.

2. To develop process-oriented models of the firms.3. To link models of the firm as closely as possible to empirical observations.

4. To develop a theory with generality beyond the specific firms studied.


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The cyert and the march model can be studied

in the following sequence:

1. Firms as a coaliation of groups with conflicting goals:the theory focuseson the decision making process of a large multi product firm under

uncertainity in an imperfect market.2. Process of goal formation-the aspiration level:each member or group of

the coaliation firm has a multiplicity of demands on the organization,oftenconflicting with the demand of the other members and with the overall goalsof the firm.

3. GOALS OF THE FIRM:The goals of the firm are set by top

management.There are five main goals of the firm-production,inventory,sales,share of the market and profit.

4. Means for resolution of the conflicts: given the limited resources of thefirm in any one period and the impossibility of satisfying alldemands,conflicts is invitable.


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5.Decision making process: decisionat top management level anddecision taken at lower level of management

6.Uncertainity and The Environment of the firm: marketuncertaintyand uncertainty of competitors reactions

7.Simple model for illustration of theory: themodel refers to the duopoly.The decision process involves the determination of the output which ishomogeneous, so that single price will ultimately prevail in the market

Criticism:

1. The behavioural theory deals realistically with the firms activity,it doesnot explain the firms behaviour under dynamic condition in the long run.

2. It cannot be used to predict exactly the future course of firms activities

3. The theory does not deals with the equilibrium of the industry

4. The theory fails to deal with interdependence of the firms and its impacton firms behaviour


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Agency Theory There has been a new development in the theoretical analysis of the firm which

suggests that profit maximisation can be a realistic assumption.This is known astheagency theory.This theory explains the agent-principal relationship in private and

public firms. Agent-principal relationship in private firm:The firm is seen as a network of

contracts between the principal and a group of agents.A firms principal is its ownerand manager are its agents.

Agent-principal relationship in public enterprise:The agent- principalrelationship in a public enterprise(company run by the government) is quitedifferent from that of a private firm.In a public enterprise,the principal is the publicand agents are parliament,civil servants and public boards that manage industriesand services.if people are not satisfied with its working,they can show theirresentment by voting out the ruling party through the ballot box in the election.

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Managerial Theories of Firms.pptx Me