Williamson (1964), like Baumol, ass

Williamson (1964), like Baumol, assumes managers have the discretion to maximise their own utility.8 Profit is again seen as a necessary constraint to ensure managerial job security.

Williamson in fact considered his model to be of more relevance to those firms operating with a strong management hierarchy and little decentralisation of decision making, referred to as a U-form (unitary-form) of organisational structure (see Chapter 2). He believed, however, that managerial discretion would be better controlled (and profit maximization maintained) in organisations with central control and a multidivision structure, with each division working as a separate profit centre and a strong degree of
managerial independence. This is generally referred to as an M-form (multi-form) structure. Williamson therefore believed that managerial discretion was better explained by organisational structure than the existence of a separation of ownership from control. However, although M-form structures might be more efficient in certain circumstances, it remains in question whether managers would then by necessity always choose to act in accordance with the wishes of shareholders.

The variables within Williamson’s managerial utility function include salaries, status, security, power and prestige. Of these variables, only salary is directly measurable in monetary terms and therefore operational within the utility function. Other variables are deemed non-pecuniary and therefore non-operational. These variables then become operational by being measured by other pecuniary variables to which they are assumed correlated. These proxy variables are staff expenditures, emoluments and discretionary investment. Management is then assumed to have an expense preference for these variables: that is, a preference for expenditure on such variables above that required for the profit maximisation of the firm

The utility function can be expressed as:
U = f (S, Id, M) to be maximised subject to a minimum profit constraint.
where:
● U = managerial utility or satisfaction
● S = staff expenditure, including managerial salaries, bonuses and share options It is assumed that management derives satisfaction from controlling and appointing additional members of staff: being in charge of more staff brings greater power, status and prestige. Obtaining more staff also implies the successful performance and future expansion of that manager’s area of operation.
● Id = discretionary investments Managerial status and power is enhanced by the discretion managers have in undertaking additional investments in excess of those required for the normal operation of the firm. Such discretionary investment allows them to gain particular satisfaction by pursuing projects in line with their own interests. These might include expenditure on sports or arts sponsorship. For instance, although purchasing a hospitality box at a local Premier League football club could be rationalised on the grounds of enhancing the firm’s public image and facilitating the entertainment of clients, it is also likely to provide additional utility to managers, particularly where the purchase coincides with their own sporting interests.

The model assumes the source of discretionary investment to be ‘discretionary profit’, where ‘discretionary profit’ is the amount of profit remaining after subtracting from actual profit the minimum profit constraint and any tax liabilities. (Therefore, reported profits would normally be in excess of the minimum profit constraint.) This is in contrast to Baumol’s model of sales revenue maximisation where the firm only aims to earn the minimum profit constraint.

● M = expenditure on managerial emoluments (perks) These could include managerial access to expense accounts, company cars, overseas business trips, luxurious offices, etc., and represent a major determinant of managerial prestige. (See the mini case ‘Cosy world of the perk ethic?’ below.) Although such ‘perks’ might be included within the manager’s overall employment package, by definition such emoluments represent payments in excess of opportunity costs, or slack (see later in this chapter). Their removal would not be assumed to cause management to seek employment elsewhere. Such ‘perks’ are possible due to the strategic position that management holds in controlling the firm.

Expenditures on S, Id and M are assumed to enhance managerial utility. However, the model assumes diminishing returns to each variable, implying that although total utility increases with the additional expenditure upon each variable, it does so at a diminishing rate, that is, the variables are subject to diminishing managerial utility. This assumption appears reasonable and in accordance with consumer theory where the consumer is assumed to gain diminishing satisfaction from additional units of a good consumed in a given time period

To maximise utility (U), managers continue to consume S, Id and M to the point where each yields the same marginal utility (MU) per pound spent. This condition can be expressed as:


The above equation therefore states that to maximise overall utility each variable should have the same (marginal) benefit to (marginal) cost ratio.10 The extra pound spent should yield the same additional utility (marginal utility) no matter which variable it is ‘spent’ on. If this were not the case, then one variable would offer more ‘marginal satisfaction per pound’ than another, and the funds would not be optimally allocated. If the relative attractiveness to management of one of the variables increased, or its ‘price of purchase’ changed, management would be assumed to alter the distribution of expenditure between the variables until the above equality is regained.

Perhaps the most interesting implication of the model is the observation that managers do not have a neutral attitude to cost. Certain expenditures, for example discretionary investments or hiring additional staff, provide management with utility over and above the return achieved from the productivity of that expenditure. In contrast, a profit maximiser only values expenditure for its productivity. Managers in
Williamson’s model therefore have an ‘expense preference’ and will not minimise cost at each level of output. In essence, ‘organisational slack’ exists within the organisation. As a consequence, profit will be lower and costs higher than in a profit-maximising situation, as expenditures on staff (and staff numbers) together with other emoluments are higher than necessary.11 However, in common with Baumol, the model does not explicitly take into account interdependence and rivalry