We said that the demands of the individual members or groups as well as the goals of the firm take the form of aspiration levels, and are continuously changing in response to past achievement, expectations and changes within the firm and its environment.

Given the limited resources of the firm in any one period, and the impossibility of satisfying all demands, conflict is inevitable. There is a continuous struggle and bargain­ing process as the various groups compete for the given resources of the firm.

Under these conditions one might think that the activity and performance of the firm would be highly unstable. This is not, however, the case. The conflict and bargaining process between the competing groups do not lead to chaotic unstable situations. Both the goals and the functioning of the firm show remarkable stability. There are various reasons for the observed stability of the goals of the various groups and of the firm.

The various members or groups have limited time to bargain, and hence they do not examine all possible alternative actions open to them at any particular time. Further­more the groups are constrained to act according to some initially agreed goals. Their behaviour is enforced by some general self-controlling devices such as the budget-share and its use by the various groups.


There are penalties for not spending the budget-share and equally severe penalties for overshooting it. An unfilled position in a department in one period is likely to be taken away and allocated to another department. Past performance in spending the budget-share creates a precedent. The firm ‘learns’ by its past mistakes, it is an adaptive organisation with a ‘memory’ of its past performance.

The behaviour, goals and decisions are based largely on past history, that is, past bargaining attainments become precedents for present bargaining, goal-setting and decision-making. Finally, there is delegation of functions in the firm, which limits the discretion of various members or groups of the coalition, thus reducing the sources of probable conflict. For these reasons objectives (of members, groups and the firm) exhibit much greater stability than would be expected in view of the conflict and the continuous bargaining process within the firm.

Apart from the budget and the delegation of authority, the smooth functioning of the firm is secured by various means which the top management uses to resolve the conflict within the firm. The most important means for the resolution of the conflict are money payments, side payments (which take the form of policy commitments), slack payments, sequential attention to the demands of the individual members or groups, and decentralization of decision-making (delegating authority for action within given limits).

1. Money payments:

Money payments are a major means for satisfying the demands of the various groups of the coalition-firm. In the traditional theory of the firm, money payments are the only means for achieving the goals of the firm the entrepreneur (being synonymous with the firm) resolves all demands by money payments, that is, by paying to the factors their market prices.


Thus, in traditional theory, there is no conflict between the owner- entrepreneur and the firm, and all the demands of the owners of factors of production are satisfied by money payments. In the behavioural theory of the firm payments of market prices to the owners of factors of production are not adequate for resolving the conflicting demands.

A large part of demands is satisfied by money payments workers and employees are getting their wages and salaries; shareholders get their dividends, and so on. However, there are other means necessary for the resolution of the conflicting demands.

2. Side payments-policy commitments:

Policy commitments absorb part of the resources of the firm and are in this sense payments to the factors of production. For example, the top management, in order to keep a good scientist in its research department, apart from paying him his salary (opportunity cost), must allocate certain funds for the development and conduct of the research plans (projects) of the scientist.

These funds are money payments which, of course, do not go into the pocket of the scientist. They form a side payment for him, in the sense that they satisfy part of his demands which are associated with his research interests. Thus side payments mostly take the form of policy commitments by the top management and are a means for satisfying some demands of the groups within the firm.

3. ‘Stack’ payments:


Slack is defined as payments to the various groups of the coalition over and above those required for the efficient working of the firm. ‘Organisational slack consists in payments to members of the coalition in excess of what is required to maintain the organisation.’ (R. M. Cyert and J. G. March, A Behavioural Theory of the Firm, Prentice-Hall, 1963.)

Slack may be ‘earned’ by all groups of the coalition. For example, workers may be paid wages higher than what is required to keep them in the firm; managers may be paid higher salaries or have other perquisites (luxurious offices, limousines, expense- accounts); shareholders may be paid higher dividends than the minimum required to satisfy their demands, customers may be given discounts which are not necessary to keep them tied to the firm.

In the long run demands of groups adjust to actual payments of the firm and of other similar firms. Thus in the long run coalition demands are analogous to the factor prices of the conventional theory. However, in the short run there is a difference between demands and payments. In periods of growth the difference is positive and this difference is what Cyert and March call slack payments. It is due to the rather slow process of adjustment of demands to actual payments to the managers and other groups of the coalition. Thus ‘slack is typically not zero’.

In managerial economics only one type of slack is discussed, namely the slack pay­ments to the managers, while the other types of slack are usually assumed to be zero. Cyert and March, while recognizing that other kinds of slack may be non-zero, still maintain that the most important form of slack is the managerial slack. As said, this may take the form of higher salaries or other perquisites that the firm provides to the top management.

The existence of slack has a stabilising effect on the performance of the firm. It allows the firm to pursue its goals and have a steady performance in a changing environment. That is, slack allows the firm to ignore to a large extent changes in its environment: in a period of ‘bad business’ the firm cuts the slack payments, thus achieving a reduction in its costs, which makes it possible for the firm not to make other major downward readjustments in its aspiration levels.

Similarly in periods of flourishing business slack payments increase, that is, part of the realized profits is absorbed in costs and hence profits appear as less than they would otherwise be so that there is less room for an excessively optimistic upward adjustment of other aspiration levels. Thus aspiration levels and the activity of the firm are more stable in a widely fluctuating environment, due to the built-in stabiliser, the slack.

Without slack and the resulting adjustment of costs the activity of the firm would be much more unstable, because the only way to adjust to changing environment would be a readjustment of aspiration levels of the firm. With slack the adjustment of the firm to the changing external conditions becomes easier: slack acts as a buffer to the changes of the environment and thus it explains the smooth functioning of the firm.

Cyert and March offer the stabilising role of slack as the explanation of the ‘orderly’ function of the firm. Yet they themselves state that this ‘role’ is played by slack ‘auto­matically.’ Slack is created autonomously because of the time-lag in the adjustment (upwards) of aspirations to achievement, and acts as an autonomous built-in stabiliser, without the top management consciously using slack as a means for the stabilisation of the firm. The hypothesis set by Cyert and March about the stabilising effect of the slack can be tested empirically by observing the behaviour of costs in bad and good business periods.

4. Sequential attention to demands:

One of the most important ways used by top management for the resolution of conflict is sequential attention to the demands of the various groups. The top manage­ment, depending on the urgency of the different demands, attaches priority and satisfies first the demands that seem more important in any one period, while postponing the demands of other members for future periods.


If in a period the production process needs renewal, the demands of the production manager will be given priority. If, however, a competitor launches a new product or a big selling campaign, the top management will allocate more funds to the sales department, giving a lower priority to other demands.

5. Decentralisation of decision-making:

Conflict is partly avoided if the decision area of each member or group is well defined. The top management organises departments and sections to which definite assignments and authority are delegated. Of course there will always be areas in which common action of managers will be required and conflict may arise, but in setting the plan of the organisation the top management tries to minimise these areas of conflict.’