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Objectives of Firms

The document discusses the objectives of business firms. It outlines several theories regarding the objectives of firms, including profit maximization, sales revenue maximization, growth rate maximization, and managerial utility maximization. It also discusses alternative objectives such as reasonable profit targets and long-run survival. The document examines different concepts of profit and debates whether profit maximization is the sole objective of firms.

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Sahil
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4K views15 pages

Objectives of Firms

The document discusses the objectives of business firms. It outlines several theories regarding the objectives of firms, including profit maximization, sales revenue maximization, growth rate maximization, and managerial utility maximization. It also discusses alternative objectives such as reasonable profit targets and long-run survival. The document examines different concepts of profit and debates whether profit maximization is the sole objective of firms.

Uploaded by

Sahil
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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OBJECTIVES OF

BUSINESS FIRMS
 what is an organisation?
“An organisation is a consciously
coordinated social unit composed of
two or more ‘people’ ,that function on
a relatively continuous basis to
achieve a common goal or set of
goals.”

“ There is no reason to believe that all


businessmen pursue the same
objective.” – Baumol
 Profit as an objective of firm
“The word profit has different meaning
to businessmen, accountants, tax
collectors, workers..” - Joel Dean
 Accounting profit Vs Economic profit
 Theories of profit
- Walker’s theory of profit – as rent of
ability
- Clark’s dynamic theory
‘ profit is an elusive sum which
entrepreneurs grasp but cannot hold. It
slips through their fingers and bestows
- Hawley’s risk theory – Residual theory of profit
- Knight’s theory of profit – Risk & Uncertainty

(A) Risk: A low probability of an expected outcome (in


common)
From business decision making point of view, risk
refers to a situation in which a business decision is
expected to yield more than one outcome and the
probability of each outcome is known to the decision
maker and can be reliably estimated.

(B) Uncertainty: It refers to a situation in which there


are more than one outcome of a business decision
and the probability of no outcome is known or can
be meaningfully estimated.

Due to – Lack of Reliable market information


- Schumpeter’s innovation theory of
profit
- Monopoly profit

 Problems in profit measurement


- Which profit concept to be used?
- What costs should be & what costs should
not be included?
> Depreciation
> Capital gains & losses
> Current Vs Historical costs – Assets;
specially inventory –
 Profit Maximisation as an objective
of firm
- It has never been unambiguously
disapproved.
- No alternative hypothesis explains &
predicts the behaviour of the firms
better than this theory.
 Conditions for maximising profit
- Necessary / first order condition:
MR = MC
- Secondary / second order
condition: The necessary condition
 The defence of profit
maximisation:
- Profit is indispensable for firm’s
survival
- Other objectives’ success is
dependent on firm’s
ability to make profit
- It has got a great predictive power
- Profit is a more reliable measure of
firm’s
efficiency
- Evidence against this objective are
 Controversy over profit
maximisation:

- Separation of ownership &


management

- Assumption of full knowledge of the


market
conditions on the part of firm is
questionable.
 Alternative objectives of firms

 B-G-M Hypothesis
- Owner controlled firms have higher
profit rates
than the manager controlled firms.
- The managers have no incentives
for profit
maximisation.
 Baumol’s Hypothesis of sales
revenue
maximisation
Managers pursue those goals which
furthers their interest.
- Salary & other management emoluments
are more closely related to sales revenue
than to profit.
- Banks & other financial institutions look
at sales revenue for credibility.
- Sales revenue trend is more readily
available indicator of the firm’s
performance
- Managers find it difficult to maximise the
 Marris’s Hypothesis of firm’s
growth rate
maximisation
“Managers try to maximise firm’s
balanced growth
rate subject to managerial & financial
constraints.”-
Robin Marris
G = G D = GC
GD = Growth rate of demand for firm’s
product
GC= Growth rate of capital supply to the
 Williamson's Hypothesis of
maximisation of managerial utility
‘ Managers seek to maximise their own
utility function.’
U = f (S, M, ID )
S = Additional expenditure on staff
M = Managerial Emoluments
ID = Discretionary investment
 Cyert - March Hypothesis of
satisficing behaviour (Simon’s
Hypothesis)
‘ A firm is a coalition of different groups
 Rothschild’s Hypothesis of long
run survival & market share
goals
‘ The primary goal of a firm is long run
survival.’
 Entry prevention & Risk
avoidance Hypothesis
Motive : a) profit maximisation in the
long run
b) Securing a constant market
share
c) Avoiding the risk caused by
A reasonable profit target

Why reasonable profit?

a) Preventing entry of new firms


b) Projecting a favourable public
image
c) Restraining trade union demands
d) Maintaining customer goodwill
e) Managerial utility function is more
preferable
to profit maximisation etc.
 Standards of reasonable profit
- Forms of profit standards
a) Aggregate money terms
b) Percentage of sales
c) Percentage of ROI
- How much profit is reasonable? -
Standards
a) Capital attracting standard
b) ‘ Plough back’ standard
c) Normal earning standards

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