ALTERNATIVE THEORIES

OF THE FIRM
GROUP MEMBERS
• SEHRISH FATIMA
• YASIR FAROOQ
• HASEEB ASLAM
• MUHAMMAD RAMZAN
• ADNAN ASLAM
 MANAGERIAL THEORIES
There are three basic managerial theories.
- Baumol’s Model of Sales Revenue Maximization.

- Marris’s Theory of Managerial Enterprise.

- Williamson’s Theory of Managerial Discretion

MANAGERIAL MODELS OF THE FIRM
• Profit Maximisation not the only goal of a firm.
• According to Baumol – Firm’s objective is “Sales
Maximisation” not “Profit Max.”
Why do firms prefer Sales Maximisation?
• Ownership and Management are separate.
• Managers and Owners have different goals.
• Managers’ goals based on Sales Maximisation because of
the following reasons:

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1. SALARIES AND PERKS TO MANAGERS DEPEND ON SALES, NOT
PROFITS.
2. Banks give loans to firms with more sales,
3. Better payment to staff, when sales, but falls when sales
decrease,
4. Sales increases prestige of managers, but large profits go to
shareholders/ owners.
5. Managers prefer steady level of profits, not maximum profits
which are difficult to maintain.
6. Increasing sales increases firm’s market power,
7. Managers wish to avoid risky ventures that may temporarily
increase profits.

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 BAUMOL’S STATIC MODEL
• Assumptions:
1. Single time period,
2. Oligopoly firm,
3. Sales Maximisation objective,
4. Minimum profit to satisfy shareholders’
expectations, keep up share prices, and meet
bank requirements,
5. U – Shaped cost curves (AC and MC), P.C. in
factor markets,
6. Downward sloping D-curve,

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 CRITICISM
• Cost and demand functions of individual firms are not known.
• Oligopoly interdependence has not been taken into account. Other
firms may also lower P, leading to P wars.
• Uncertainties in oligopoly, not discussed.
• Relationship between firm and industry equilibrium not shown.
• Owners may demand higher profits not sales.

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• Prof Hall in his analysis of 500 firms came to the conclusion that firms do not
operate in accordance with the object of sales maximization.

• Hawkins has also shown that Baumol's conclusion that a sales maximiser will in
general produce and advertise more than a profit maximiser, is invalid. According to
Hawkins, a sales maximiser “may choose a higher, lower or identical output, and a
higher, lower or identical advertising budget. It depends on the responsiveness of
demand to advertising rather than price.

• According to Shepherd, under oligopoly a firm faces a kinked demand curve and if
the kink is large enough, total revenue and profits would be the maximum at the
same level of output. So both the sales maximiser and the profit maximiser would
not be producing different levels of output.
 MARRIS’S THEORY OF
ENTERPRISE.

•“In corporate firm, there is a structural division of ownership and

management which allows managers to set goals which do not necessarily
confirms with those of the owners.”
 OWNER
S
The shareholders are the owners of
organizations. Their utility functions
includes variables such as:-
- Profits
- Size of output
- Size of Capital
- Market Share
- Public Image
CRITICALLY EXAMINE MARRIS’S THEORY:
R. Marris has made a significant contribution in the form of
incorporation of the financial policies into the decision
making process of the corporate firm. His theory suggests
that although the managers and the owners have different
goals, it is possible to find a solution which maximises
utility of both. Nonetheless Marris shows that growth and
profits are competing goals. His model implies that both
managers and owners are conscious of the fact that the
firm cannot simultaneously achieve maximum growth and
maximum profits. Marris seems to be correct in arguing
that owners of the corporate firms do prefer the
maximisation of the rate of growth and for this they do not
mind sacrificing some profits.
CRITICALLY EXAMINE MARRIS’S THEORY:(CONTD.)

The main weakness of Marris’s Theory is that he assumes

given production costs and a price structure. He does not
explain determination of either costs or prices.

A. Koutsoyiannis writes “Oligopolistic interdependence is not

satisfactorily dealt with in Marris’s model. Really Marris
brushes aside the mechanism by which prices are
determined. This is a serious shortcoming of the model, in
view of Marris’s assumption that the growth of the firm is
achieved mainly via the introduction of new products which
will (sooner rather than later) be imitated by competitors.”
 WILLIAMSON’S MODEL OF
MANAGERIAL DISCRETION
Manager’s discretion
• Managers, in imperfect markets, want to maximize their own Utility,
• not profits for owners or shareholders.
• They have the discretion to do so.
• Williamson’s model differs from Baumol’s in four ways:

 Minimum profits for minimum investment and growth of the firm.

 Managers want to maximize their own utility.
 CRITICISM:

 No empirical proof of such managerial behavior.

 Managers may not have so much freedom,
 Trade unions may demand more S,
 The model does not discuss how price is determined.
 Interdependence in oligopoly is not discussed.
1.As pointed by Boumol, sales maximize will in general produce and advertise
more than a profit maximize, which is invalid. Hawkins comments that a sales-
maximizer may choose a higher, lower or identical output and a higher, lower
or advertising budget. It depends on the responsiveness of demand to
advertising rather than price cuts.
2.In case of multi-products, Baumol has argued that revenue and profit
maximization yield the same results. But Williamson has shown that sales
maximization yields different results from profit maximization.
3.This model fails to explain observed market situations in which price are kept
for considerable time periods in the range of inelastic demand.
4.This model ignores the interdependence of the price of oligopolistic firms.
5.It ignores not only actual competition, but also the threat of potential
competition from rival oligopolistic firms.
6.This model does not show how equilibrium in an industry in which all firms
are sales maximizers, will be attained. Baumol does not establish the
relationship between the firms and industry.
Behavioural Theories of the Firm:
Definition of Behavioural Theories of the Firm:
Behavioural theory of the firm (BTF) is a composition of a number of theories
that have
emerged within economics, sociology, business and management studies – to
deal with the issues of how firms behave in a market place and what
determines the inter-firm relationships.
The behavioral theory of the firm first appeared in the 1963 book A
Behavioral Theory of the Firm by Richard M. Cyert and James G. March. The
work on the behavioral theory started in 1952 when March, a political scientist,
joined Carnegie Mellon University, where Cyert was an economist.
Before this model was formed, the existing theory of the firm had two main
assumptions: profit maximization and perfect knowledge. Cyert and March
questioned these two critical assumptions
Cyert and March:
These researchers offered four major research themes:
A small number of key economic decisions
Development of a general theory, generalizing the results from
studies of specific firms
Linkage of empirical data to models
Orientation towards process rather than outcomes
Critical evaluation:
The behavioral model made a great impact on the theory of the firm. It
gave insights in the process of goal formation and fixation of aspiration
levels and resource allocation. Its critics[who?] claim that the theory is
unnecessarily complicated. The virtual assembly of the firm, with the
decision making process as the unit, for the purpose of predicting their
behaviour is highly questioned by critics. There has also been staunch
support for profit maximization rather than satisficing behaviour, which is
one of the core elements of the model
Criticisms of Behaviorism:
Many critics argue that behaviorism is a one-dimensional approach to
understanding human behavior and that behavioral theories do not
account for free will and internal influences such as moods, thoughts and
feelings. As my professor told us, behaviourism tends to be “superficial”
or shallow in explaining behavior and learning. It only considers what is
observable and measurable, well in fact there are various unseen aspects
of an individual that are very vital in his or her personalities and learning
capabilities.
Behaviorism does not account for other types of learning,
especially learning that occurs without the use of reinforcement and 
punishment. As can be inferred from the theory presented, much of the
human behavior and learning abilities were attributed to the effects of
external factors that serve as reinforcers or punishers. As contested by
other proponents like Albert bandura, not everything can be explained
by outside influence as mentioned. Still, there are many different ways.
People and animals are able to adapt their behavior when new
information is introduced, even if a previous behavior pattern has
been established through reinforcement.  It only says that regardless of
what behavior an individual learned in the past through the system of
reinforcement, he can still be able to modify and/or change it when new
circumstances offer new information. I believe that this is true as we
also have the process of extinction. As we continue to live, we will
encounter many more opportunities for learning.