2. Three theories of
Managerialism
1. Baumol’s Model of Sales Revenue maximization.
2. Marris’s Theory of Managerial Enterprise
3. Williamson’s Theory of Managerial Discretion
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.
9.
10.
11. 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.
12. 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.
13. 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.
14. 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.
15. 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.
16. 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.
17. 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.
18. 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.
19. 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.
20. 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.”
22. 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.
23. 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.
24. WILLIAMSON’S THEORY OF
MANAGERIAL DISCRETION
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.
25. Basic concepts:
Various concepts of Profit:
The actual profit: Sales Revenue minus
production costs and less staff expenditure.
= R – C – S
The reported Profit : is the profit that
the firm reports to the tax authorities. It is
the actual profit less tax deductible
managerial emoluments.(M)
= - M = R – C – S - M
26. Various concepts of profit:
Minimum Profit: o 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.
o < R – T (T= Tax)
The Discretionary Profit: D is the amount of profit
left after subtracting the minimum profit and the
tax from the actual profit.
D = - o - T
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 = R - o - T
