3. Three theories of Managerialism
• 1. Baumol’s Model of Sales Revenue
maximisation.
• 2. Marris’s Theory of Managerial Enterprise
• 3. Williamson’s Theory of Managerial
Discretion
4. Baumol’s Model of
Sales Revenue Maximisation
W.J.Baumol suggested
Sales Revenue maximisation as an
alternative goal to profit maximisation.
Managers only ensure acceptable level of
profit, pursuing a goal which enhances
their own utility.
5. Baumol’s Model : (contd.)
Rationale of the Hypothesis:
1. Management has been separated from
ownership in modern times.
2. This has given powers to Managers who
pursue their own goals rather than the goal
of the owners.
3. Managers ensure a minimum acceptable
level of profit to satisfy the shareholders,
but would pursue a goal which enhances
their own utility.
6. Baumol’s Model : (contd.)
Why Managers attempt to maximise sales rather than
profits:-
1. Incomes of top executives are closely related to
sales rather than profits.
2. Banks and financial institutions are impressed
by the amount of sales and treat this as a good
indicator of the performance of the firm.
3. Large and continuing sales enhance prestige of
the Managers, who ensure regular distribution of
dividends.
7. Baumol’s Model : (contd.)
4 A steady performance with satisfactory amount
of profits is preferably to irregular spectacular
profits in some one or two years. Having shown
high profits, if the level is not maintained, it will
lead to discontent of shareholders.
5. Large sales strengthens the competitive power of
the firm vis-avis competitors, while low or
declining sales diminishes this power of
bargaining.
8. Separation of ownership and management
combined with the desire for steady
performance which ensures satisfactory
profits, tend to make the managers risk
avoiders. Top Managers in the modern firm
are generally reluctant to adopt highly
promising but risk-prone projects. But this
approach stabilises the economic
performance of the firm and leads to
development of orderly markets.
9. Basic assumptions in Baumol’s Static Models:
1. A firm’s decision making is limited to a single
period. During this period, the firm attempts to
maximise total revenue rather than physical
volume of sales.
2. Sales revenue maximisation is subject to
provision of minimum required profit to ensure a
fair dividend to shareholders, thus ensuring
stability of his job.
3. Conventional Cost and Revenue functions are
assumed – Cost curves are U-shaped, Demand
curve is downward sloping.
10. Marris’s Theory of
The Managerial Enterprise
“In Corporate firms, there is structural division of
ownership and management which allows
managers to set goals which do not necessarily
conform with those of the owners. The
shareholders are the owners. Their utility function
includes variables such as
profits,
size of output,
size of capital,
market share and
public image.
11. Marris’s Theory of
The Managerial Enterprise(contd.)
“
The Managers have other ideas. Their utility
function includes variables such as
Salaries,
Job security,
Power and status.
12. Marris’s Theory of
The Managerial Enterprise(contd.)
• The owners want to maximise their utility while
the managers attempt maximisation of their own
utility.
• Both utilities do not necessarily clash, because the
most of the variables of both the utilities, have a
strong relationship with a single variable
• i.e., size of the firm.
• It is reasonable to assume that maximising the
long-run growth of any indicator is equivalent to
maximising the long-run growth rate of the others.
13. Marris’s Theory of
The Managerial Enterprise(contd.)
• Owners being interested in the growth of the firm
want maximisation of the growth of the supply of
capital, which is assumed to maximise the owner’s
utility.
• Managers wanting to maximise rate of growth of
the firm rather than absolute size of the firm,
believe that growth of demand for the products is
an appropriate indicator of the growth of the firm.
14. • There are two constrains in the Marris’s Model:
• 1. The Managerial Team Constraint.
Since Management is a teamwork, hiring new
managers does not expand managerial capaqcity
immediately. New managers take time to get
integrated in the team. Managerial tream
constraint sets limits to both the rate of growth of
demand and rate of growth of capital.
• 2. The Job Security Constraint. Managers want
job security. Job security attained by pursuing a
prudent financial policy which requires the three
crucial financial ratios to be maintained at
optimum levels.
15. Liquidity Ratio: Current ratio – ratio of liquid assets to
total assets.
Low liquidity increases the risk of insolvency (risk=+ve)
Leverage/Debt or Debt-Equity ratio: ratio of debt to total
assets.
High debt-equity ratio exposes the firm to bankruptcy.
(risk=+ve)
Profit retention ratio: High retention of profits, adds to
the reserves contributing to the growth of capital.
(risk= -ve)
Combining all the above into a single parameter will
amount to financial constraint of the firm.
16. Policy variables in Marris’s balanced growth model
are as follows:
• 1. The firm has the freedom to choose its financial policy, as it
subjectively determines the three financial ratios, liquidity ratio,
leverage/debt ratio and retention ratio.
• 2. The firm can decide its diversification rate, either by expanding the
range of its products, or by merely effecting a change in the style of its
existing range of products. OR it can adopt the two policies
simultaneously.
• 3. Price is not a policy variable of the firm. It is a parameter. Price is
taken as given by the oligopolistic structure of the market. Production
costs are also taken as given.
• 4. The firm has the freedom to decide the level of it advertising and
R&D. Since Price and Production Costs are given, increase in advt. &
R&D, will imply lower profit margin and vice-versa.
17. Marris’s Model:
The rate of growth of demand for the products of the firm:
• The firm is assumed to grow by diversification and not by merger or
acquisition.
• The growth of demand for the products of the firm depends on the rate
of diversification and the proportion of successful new products.
The rate of growth of capital supply:
• The shareholders who are the owners, wish to maximise company's
capital, which is the measure of the size of the firm.
• The main source of finance for the growth of the firm is profit but the
management can retain only part of it, for another part has to be
distributed as dividend.
The rate of growth of capital is determined by three factors: the three
financial ratios determined by the managers constituting the
financial security constraint, the average rate of profit, and the
rate of diversification.
18. 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.
19. 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 ar 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.”
21. WILLIAMSON’S THEORY OF
MANAGERIAL DISCRETION
Williamson is of the opinion that the managers of a
modern business firm organised as a corporate
unit do not maximise the profits which result in
the maximisation of the utility of the owners.
Onstead they maximise their own utility using
their discretion. However, for their job security,
managers attempt to ensure a certain minimum of
profit to shareholders in the form of dividends.
Thus profit is a constraint to the manager’s
discretion.
22. WILLIAMSON’S THEORY OF
MANAGERIAL DISCRETION
• Managers’ utility depends on such variables as
salary, job security, power, prestige, status, job
satisfaction and professional excellence. Of these
variables only salary can be quantified. Therefore,
Williamson uses measurable variables like staff
empenditures, managerial emoluments and
discretionary investment in the utility function of
managers on the assumption that these are the
source of the job security and reflect power,
prestige, status and professional achievements of
managers.
23. WILLIAMSON’S THEORY OF
MANAGERIAL DISCRETIONΠ
Basic Concepts:
The demand for the firm. The firm’s demand curve is
assumed to be downward sloping and is defined by the
function
X = f1 (P, S, e)
P = f2 (X, S, e)
Where X = output, P = price, S = staff expenditure
e = a demand shift parameter reflecting autonomous changes in
demand.
The demand is negatively related to price and is assumed to be
positively related to staff expenditure and to the shift factor.
24. Basic concepts:
Various concepts of Profit:
The actual profit: Sales Revenue minus
production costs and less staff expenditure.
Π =R–C–S
The reported Profit : Π is the profit that the firm
reports to the tax authorities. It is the actual profit
less tax deductible managerial emoluments.(M)
Π = Π−Μ =R–C–S-Μ
25. Various concepts of profit:
Minimum Profit: Πο is required to satisfy the shareholders.
If this profit is not earned, the shareholders will either sell
their shares or change the top management, adversely
affecting the job security of managers.
Πο < ΠR – T (T= Tax)
The Discretionary Profit: Π D is the amount of profit left after
subtracting the minimum profit and the tax from the actual
profit.
ΠD = Π − Πο − Τ
Discretionary Investment: ID - Discretionary investment is
the amount that is left from the reported profit after
subtracting the minimum profit and the tax from the
reported profit.
ID = ΠR − Πο - T
