16.pdf
- 1. OBJECTIVES OF OBJECTIVES OF BUSINESS FIRMS BUSINESS FIRMS
- 2. whaT IS aN ORgaNISaTION? whaT IS aN ORgaNISaTION? “ “An organisation is a consciously An organisation is a consciously coordinated coordinated social unit social unit composed of two or more ‘people’ ,that composed of two or more ‘people’ ,that function on a relatively continuous basis to function on a relatively continuous basis to achieve a common achieve a common goal or set of goals goal or set of goals.” .” “ “ There is no reason to believe that all businessmen There is no reason to believe that all businessmen pursue the same objective.” – Baumol pursue the same objective.” – Baumol
- 3. PROFIT aS aN OBJECTIVE OF FIRM PROFIT aS aN OBJECTIVE OF FIRM “ “The word profit has different meaning to The word profit has different meaning to businessmen, accountants, tax collectors, workers..” businessmen, accountants, tax collectors, workers..” - Joel Dean - Joel Dean Accounting profit Vs Economic profit Accounting profit Vs Economic profit Theories of profit Theories of profit - Walker’s theory of profit – as rent of ability - Walker’s theory of profit – as rent of ability - Clark’s dynamic theory - Clark’s dynamic theory ‘ ‘ profit is an elusive sum which entrepreneurs grasp profit is an elusive sum which entrepreneurs grasp but cannot hold. It slips through their fingers and but cannot hold. It slips through their fingers and bestows on all members of the society.’ – J.B.Clark bestows on all members of the society.’ – J.B.Clark
- 4. - Hawley’s risk theory – Residual theory of profit - Hawley’s risk theory – Residual theory of profit - Knight’s theory of profit – Risk & Uncertainty - Knight’s theory of profit – Risk & Uncertainty (A) (A) Risk Risk: : A low probability of an expected outcome (in common) A low probability of an expected outcome (in common) From business decision making point of view, risk refers to a From business decision making point of view, risk refers to a situation in which a business decision is expected to yield more than situation in which a business decision is expected to yield more than one outcome and the probability of each outcome is known to the one outcome and the probability of each outcome is known to the decision maker and can be reliably estimated. decision maker and can be reliably estimated. (B) (B) Uncertainty Uncertainty: It refers to a situation in which there are more than : It refers to a situation in which there are more than one outcome of a business decision and the probability of no one outcome of a business decision and the probability of no outcome is known or can be meaningfully estimated. outcome is known or can be meaningfully estimated. Due to – Lack of Reliable market information Due to – Lack of Reliable market information - Inadequate past experience - Inadequate past experience - High volatility of market conditions - High volatility of market conditions
- 5. - Schumpeter’s innovation theory of profit - Schumpeter’s innovation theory of profit - Monopoly profit - Monopoly profit PROBlEMS IN PROFIT MEaSUREMENT PROBlEMS IN PROFIT MEaSUREMENT - Which profit concept to be used? - Which profit concept to be used? - What costs should be & what costs should not be included? - What costs should be & what costs should not be included? > Depreciation > Depreciation > Capital gains & losses > Capital gains & losses > Current Vs Historical costs – Assets; specially inventory – > Current Vs Historical costs – Assets; specially inventory – FIFO, LIFO & WAC FIFO, LIFO & WAC
- 6. PROFIT MaxIMISaTION aS aN PROFIT MaxIMISaTION aS aN OBJECTIVE OF FIRM OBJECTIVE OF FIRM - It has never been unambiguously disapproved. It has never been unambiguously disapproved. - No alternative hypothesis explains & predicts No alternative hypothesis explains & predicts the behaviour of the firms better than this the behaviour of the firms better than this theory. theory. Conditions for maximising profit Conditions for maximising profit - - Necessary / first order condition: Necessary / first order condition: MR = MC MR = MC - - Secondary / second order condition: Secondary / second order condition: The necessary The necessary condition must be satisfied under the condition condition must be satisfied under the condition of decreasing MR & rising MC of decreasing MR & rising MC
- 7. The defence of profit maximisation: The defence of profit maximisation: - - Profit is indispensable for firm’s survival Profit is indispensable for firm’s survival - - Other objectives’ success is dependent on firm’s Other objectives’ success is dependent on firm’s ability to make profit ability to make profit - It has got a great predictive power - It has got a great predictive power - Profit is a more reliable measure of firm’s - Profit is a more reliable measure of firm’s efficiency efficiency - Evidence against this objective are not conclusive - Evidence against this objective are not conclusive ( Hall & Hitch survey) ( Hall & Hitch survey) - Purpose of traditional theory of value is different - Purpose of traditional theory of value is different (Fritz Maclup’s observation) (Fritz Maclup’s observation)
- 8. Controversy over profit maximisation: Controversy over profit maximisation: - Separation of ownership & management - Separation of ownership & management - Assumption of full knowledge of the market - Assumption of full knowledge of the market conditions on the part of firm is questionable. conditions on the part of firm is questionable. - Marginality principle is not widely in use. - Marginality principle is not widely in use.
- 9. alTERNaTIVE OBJECTIVES OF FIRMS alTERNaTIVE OBJECTIVES OF FIRMS B-G-M Hypothesis B-G-M Hypothesis - Owner controlled firms have higher profit rates - Owner controlled firms have higher profit rates than the manager controlled firms. than the manager controlled firms. - The managers have no incentives for profit - The managers have no incentives for profit maximisation. maximisation.
- 10. Baumol’s Hypothesis of sales revenue Baumol’s Hypothesis of sales revenue maximisation maximisation Managers pursue those goals which furthers their Managers pursue those goals which furthers their interest. interest. - Salary & other management emoluments are more - Salary & other management emoluments are more closely related to sales revenue than to profit. closely related to sales revenue than to profit. - Banks & other financial institutions look at sales - Banks & other financial institutions look at sales revenue for credibility. revenue for credibility. - Sales revenue trend is more readily available indicator - Sales revenue trend is more readily available indicator of the firm’s performance of the firm’s performance - Managers find it difficult to maximise the profit - Managers find it difficult to maximise the profit consistently due to changing & challenging conditions. consistently due to changing & challenging conditions. - - Static & Dynamic model Static & Dynamic model
- 11. Marris’s Hypothesis of firm’s growth rate Marris’s Hypothesis of firm’s growth rate maximisation maximisation “ “Managers try to maximise firm’s Managers try to maximise firm’s balanced growth balanced growth rate rate subject to managerial & financial constraints.”- subject to managerial & financial constraints.”- Robin Marris Robin Marris G = G G = GD D = G = GC C G GD D = Growth rate of demand for firm’s product = Growth rate of demand for firm’s product G GC C= Growth rate of capital supply to the firm = Growth rate of capital supply to the firm Um = f (salary, power, job security, prestige, status..) Um = f (salary, power, job security, prestige, status..) Uo = f (output, capital, market share, profit, public Uo = f (output, capital, market share, profit, public esteem..) esteem..) ‘ ‘ Size of the firm’ Size of the firm’
- 12. Williamson's Hypothesis of maximisation of Williamson's Hypothesis of maximisation of managerial utility managerial utility ‘ ‘ Managers seek to maximise their own utility Managers seek to maximise their own utility function.’ function.’ U = f (S, M, I U = f (S, M, ID D ) ) S = Additional expenditure on staff S = Additional expenditure on staff M = Managerial Emoluments M = Managerial Emoluments I ID D = Discretionary investment = Discretionary investment Cyert - March Hypothesis of satisficing Cyert - March Hypothesis of satisficing behaviour (Simon’s Hypothesis) behaviour (Simon’s Hypothesis) ‘ ‘ A firm is a coalition of different groups with A firm is a coalition of different groups with conflicting goals.’ – conflicting goals.’ – Aspiration level of the firm Aspiration level of the firm
- 13. Rothschild’s Hypothesis of long run Rothschild’s Hypothesis of long run survival & market share goals survival & market share goals ‘ ‘ The primary goal of a firm is long run survival.’ The primary goal of a firm is long run survival.’ Entry prevention & Risk avoidance Entry prevention & Risk avoidance Hypothesis Hypothesis Motive Motive : : a) profit maximisation in the long run a) profit maximisation in the long run b) Securing a constant market share b) Securing a constant market share c) Avoiding the risk caused by the c) Avoiding the risk caused by the unpredictable behaviour of new firms unpredictable behaviour of new firms
- 14. A reasonable profit target A reasonable profit target Why reasonable profit? Why reasonable profit? a) Preventing entry of new firms a) Preventing entry of new firms b) Projecting a favourable public image b) Projecting a favourable public image c) Restraining trade union demands c) Restraining trade union demands d) Maintaining customer goodwill d) Maintaining customer goodwill e) Managerial utility function is more preferable e) Managerial utility function is more preferable to profit maximisation etc. to profit maximisation etc.
- 15. Standards of reasonable profit Standards of reasonable profit - - Forms of profit standards Forms of profit standards a) Aggregate money terms a) Aggregate money terms b) Percentage of sales b) Percentage of sales c) Percentage of ROI c) Percentage of ROI - How much profit is reasonable? - Standards - How much profit is reasonable? - Standards a) Capital attracting standard a) Capital attracting standard b) ‘ Plough back’ standard b) ‘ Plough back’ standard c) Normal earning standards c) Normal earning standards