Maximizing Profits as the Main Goal
The traditional theory (neoclassical) assumes that firm’s primary
objective is to maximize profits. That is if the firm is owner
controlled. This assumption is based on that firms makes the output
and price decisions. Also, that firm takes all necessary actions to
earn the greatest profit possible. The managerial theory assumes firms
do not necessarily act in order to maximize profits. The basic tenet
behind this is the separation of ownership from management, complexity
of the organisation and the firm’s manager maximizes his own utility
and growth rather than profits. The reason for this is that managers
may be judged by the level of sales revenue. I will be providing
supporting arguments for and against this assumption “that the firm’s
main motivation is to maximise profits” and draw a conclusion by
analysing the firms behaviour as well as further discussing the
theories of firms.
Profit maximising assumption is based on two premises, firstly that
owner is in control of day-to-day management of the firm and secondly
that the main desire of owners is to make a higher profit then the
amount they invested in the firm. Since this assumption is based on
two assumptions, therefore if these two premises don’t hold is it
understandable to believe that firms goals is not to maximize profits.
Well, this will depend on the motivation of individual firms.
If a firm’s ownership and control are in the hands of a single person
or small groups of people, then it’s reasonable to assume that the
firm’s owners’ goal is to maximize profits. But most of today’s firms
are owned by shareholders and other large cooperation, but day-to-day
control of the firm is under management. Therefore, the objectives of
managements may differ from the shareholders and conflicts may arise.
“For example Baumal (1959) suggest that the manager-controlled firm is
likely to have sales revenue maximization, as its main goal than
profit maximization favoured by shareholders” (Applied Economics 7th
ed. p54). Also, studies of 177 firms between 1985 and 1990 by Conyon
and Gregg (1994) found that the pay of top executive of large firms in
UK was mostly related to sales growth.
Other studies have found that profit was the most important
determinant of executive income. For example “A survey by Management
Today in 1990 asserted that top executives pay was closely related to
profit performance” (Applied Economics 7th Ed. p63). Again research by
the US Strategic Planning Institute (Schoeffler, Buzzel and Heany
1994) indicates that in the short-run strategic planning support the
idea of short-term sales revenue maximization by sacrificing
profitability or growth. These studies also, found that there’s a link
between market share and sales revenue. Market share had a significant
and beneficial effect on both return of investment and cash flow, in
the long-run. Hence, firms are seen as profit maximizers, as...