Market forces therefore act as a constraint upon management. In highly competitive markets, management must achieve profit maximisation. The constraint is less where competitive forces are weaker. However, the dominance of oligopolistic markets in modern economies provides plenty of scope for non-profit-maximising behavior Nevertheless, competition is strong in all markets and firms cannot afford to neglect efficiency and profitability. However, as we will see below, profit now appears as a constrain upon behaviour rather than the sole or dominating goal of the firm.
Alternative theories of the firm
Traditional theories of the firm broadly envisage a situation where the owner-manager (or entrepreneur), armed with perfect knowledge of the internal working of the firm and its competitive environment, pursues maximum profit by equating marginal cost to marginal revenue. The entrepreneur is assumed to have no objectives other than profit. All profit comes to the entrepreneur as the firm’s owner.
This view cannot be seen as an accurate description of a typical modern enterprise. The question is, therefore, how do firms behave? New or alternative theories need to take into account current organisational structures and particularly the emergence of the public joint-stock company. The appearance of such companies and the separation of ownership from control has led to the development of alternative theories of the firm. Although profit plays an important role in such theories, it may no longer be seen as the sole or dominating goal of the firm.
There are two generic types of alternative theory, namely:
1managerial theories
2behavioural theories.
6.3.1 Managerial theories
The starting point of all managerial theories is the assumption of a divorce of ownership from control. It is also assumed that top managers are able to dominate decision making through their ability to determine company strategy, future investments, promotions and the appointment of persons to key company positions.
In common with the traditional neo-classical approach, these are also maximizing theories. However, in place of profit, managers are now assumed to maximise their own utility or satisfaction subject to a minimum profit constraint. Managerial theories differ from one another in terms of the factors or objectives that determine managerial utility, and how those objectives might be achieved.
Although profit is no longer seen as the sole aim of the firm, its relevance remains in the sense that a firm’s management can only pursue its own goals when shareholders receive an acceptable minimum level of profit. If this were not the case, managers would risk jeopardising their position, as shareholders will either collectively seek to replace them, or else sell their shares and increase the likelihood of takeover. In such theories, profit therefore appears as a constraint upon managerial behaviour.
There are a number of management theories each associated with a particular economist and a specific maximising goal. We will examine three:
1W.J.Baumol – ‘sales revenue maximisation’
2O.E.Williamson – ‘managerial utility maximisation’
3R.Marris – ‘company growth maximisation’.