Alternative Objectives of Business Firms

Some important alternative objectives of business firms are discussed below:

(i) Baumol’s Hypothesis of Sales Revenue Maximistion:

Prof. Baumol has postulated maximisation of sales revenue as an alternative to profit- maximisation objective.

The reason behind this objective is the dichotomy between ownership and management. This dichotomy gives managers an opportunity to set their goals other than profit maximisation which most owner-businessmen pursue.

Given the opportunity, managers choose to maximise their own utility function. According to Baumol, the most plausible factor in managers’ utility functions is maximisation of the sales revenue.

The factors which explain the pursuance of this goal by the managers are:

(i) Salary and other earnings of managers are more closely related to sales revenue than to profits,

(ii) Banks and financial corporation’s look at sales revenue while financing the corporation,

(iii) Trend in sale revenue is a readily available indicator of performance of the firm. It helps also in handling the personnel problem,

(iv) Increasing sales revenue enhances the prestige of managers while profit goes to the owners;

(v) Managers find profit maximisation a difficult objective to fulfill consistently over time and at the same level. Profits may fluctuate with changing conditions,

(vi) Growing sales strengthen competitive spirit of firm in the market and vice versa.

As empirical validity of sales maximisation objective is concerned, factual evidences are inconclusive. Most empirical works are in fact, based on inadequate data as requisite data are mostly not available. Even theoretically, if total cost function intersects the total revenue function (TR) before it reaches its climax, Baumol’s theory collapses. Besides, it is also argued that, in the long run, sales maximisation and profit maximisation objectives converge into one. For, in the long run, sales maximisation tends to yield only normal levels of profit which turns out to be the maximum under competitive conditions. Thus, profit maximisation is not incompatible with sales maximisation.

(ii) Marris’ Hypothesis of Maximisation of Firm’s Growth Rate:

Marris has suggested another alternative objective, i.e., maximisation of balanced growth rate of the firm. Marris recognizes the dichotomy between owners’ and managers’ interest. Accordingly, he assumes that owners and managers having their own utility functions to maximise. The managers’ utility function (U_m) and owners’ utility function (U_D) may be specified as

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

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

Owner’s utility function (U₀) implies growth of demand for firm’s product and supply of capital. Therefore, maximisation of U_G means maximisation of ‘demand for firm’s product’ or ‘growth of capital supply’. According to Marris, by maximising these variables, managers maximise both their own utility function and that of the owners.

The managers can do so because most of the variables (e.g., salaries, status, job security, power, etc.) appearing in their own utility function and those appearing in the utility function of the owners (e.g., profit, capital market share, etc.) are positively and strongly correlated with a single variable, i.e., size of firm. Maximisation of these variables depends on the maximisation of the growth rate of the firms. The managers therefore seek to maximise a steady growth rate.

Marris’s theory fails to deal satisfactorily with oligopolistic interdependence. Another shortcoming is that it ignores price determination which is the main concern of profit maximisation hypothesis. Marris’s model too does not seriously challenge the profit maximisation hypothesis.

(iii) Williamson’s Hypothesis of Maximisation of Managerial Utility Function:

Like Baumol and Marris, Willamson argues that managers have discretion to pursue objectives other than profit maximisation. The managers seek to maximise their own utility function subject to a minimum level of profit. Manager’s utility function (U) is expressed as:

U = f (S, M, I_D)

where S = additional expenditure on staff

M = Managerial emoluments,

Id = Discretionary investments,

According to Williamson’s hypothesis, managers maximise their utility function subject a satisfactory profit. A minimum profit is necessary to satisfy the shareholders; otherwise manager’s job security is endangered. The utility functions which managers seek to maximize include both quantifiable variables like salary and slack earnings, and non-quantitative variable such as prestige, power, status, job security, professional excellence, etc.

The non-quantifiable variables are expressed, in order to make them operational, in terms of expense preference defined as ‘satisfaction derived out of certain types of expenditures’ (such as slack payments), and ready availability of funds for discretionary investment.

Thus, Williamson’s theory too suffers from certain weaknesses. His model fails to deal with problem of oligopolistic interdependence. It is said to hold only where rivalry is not strong. In case of strong rivalry, profit maximisation is claimed to be a more appropriate hypothesis. Thus, Williamson’s managerial utility function too does not offer a more satisfactory hypothesis than profit maximisation.

(iv) Cyert-March Hypothesis of Satisfying Behaviour:

Cyert-March hypothesis is an extension of Simon’s hypothesis of firms, ‘satisfying behaviour’. Simon had argued that the real business world is full of uncertainty; accurate and adequate data are not readily available; where data are available managers have little time and ability to process them; and managers work under a number of constraints.

Under such conditions it is not possible for the firms to act in terms of rationality postulated under profit maximisation hypothesis. Nor do the firms seek to maximise sales, growth or anything else. Instead they seek to achieve a ‘satisfactory profit,’ a ‘satisfactory growth’, and so on. This behaviour of firms is termed as ‘Satisfaction Behaviour’.

Cyert and March added that, apart from dealing with an uncertain business world, managers have to satisfy a variety of group of people-managerial staff, labour, shareholders, customers, financers, input suppliers, accountants, lawyers, authorities, etc. All these groups have their interest in the firms-often conflicting.

The managers’ responsibility is to satisfy them all. Thus, according to the “Behavioural Theory of Firms’, firm’s behaviour is ‘Satisfying Behaviour’. The underlying assumption of ‘Satisfying Behaviour’ of firms is that a firm is a coalition of different groups connected with various activities of the firms, e.g., shareholders, managers, workers, input supplier, customers, bankers, tax authorities, and so on. All these groups have some kind of expectations high and low- from the firm, and the firm seeks to satisfy all of them in one way or another by sacrificing some of its interest.

In order to reconcile between the conflicting interests and goals, managers form an aspiration level of the firm combining the following goals:

(a) Production goal,

(b) Sales and market share goals,

(c) Inventory goal, and

(d) Profit goal.

These goals and ‘aspiration level’ are set on the basis of the managers’ past experience and their assessment of the future market conditions. The ‘aspiration levels’ are modified and revised on the basis of achievements and changing business environment.

The behavioural theory has however been criticized on the following grounds:

First, though the behavioural theory deals realistically with the firm’s activity, it cannot explain the firm’s behaviour under dynamic conditions in the long run.

Secondly, it cannot be used to predict exactly the future course of firm’s activities. Thirdly, this theory does not deal with equilibrium of the industry. Fourthly, like other alternative hypotheses, this theory, too fails to deal with interdependence and interaction of the firms.

(v) Rothschild’s Hypothesis of Long-run Survival and Market Share Goals:

Another alternative objective of a firm – as an alternative to profit maximisation- was suggested by Rothschild. According to him, the primary goal of the firm is long-run survival. Some others have suggested that attainment and retention of a constant market share is the objective of the firms.

The managers therefore seek to secure their market share and long- run survival, the firms may seek to maximise their profit in the long-run, though it is not certain.

(vi) Entry-prevention and Risk-avoidance:

Yet another alternative objective of the firms suggested by some economists is to prevent entry of new firms into the industry.

The motive behind entry-prevention may be:

(a) Profit maximisation in the long run,

(b) Securing a constant market share, and

(c) Avoidance of risk caused by the unpredictable behaviour of the new firms.

The evidence of whether firms maximise profits in the long run is not conclusive. Some argue that where management is divorced from the ownership, the possibility of profit maximisation is reduced. Some argue that only profit-maximising firms can survive in the long run. They can achieve all other subsidiary goals easily if they can maximise their profits.

It is further argued that, prevention of entry may be the major objective in the pricing policy of the firm, particularly in case of limit pricing. But then, the motive behind entry- prevention is to secure a constant share in the market. Securing constant share, market share is compatible with profit maximisation.