2) Objectives of Firms 2

Question 1

principal-agent problem definition

Answer 1

arises from conflict between the objectives of the principals and their agents, who take decisions on their behalf

Question 2

principals definition

Answer 2

business owners

Question 3

agents definition

Answer 3

managers running a business on a shareholders’ behalf

Question 4

utility maximisation definition

Answer 4

managers maximising their utility

Question 5

social welfare definition

Answer 5

a firm existing to benefit wider society

Question 6

corporate social responsibility (CSR) definition

Answer 6

a firm acting to benefit wider society, the community or their emplovees

Question 7

CSR examples

Answer 7

ESG, Guardian, charity, HCHS, network rail

Question 8

profit satisficing definition

Answer 8

managers doing just enough to satisfy shareholders by producing satisfactory profits

Question 9

what is the principle agent problem?

Answer 9

• The principals of a firm are the owners; usually Share holders

• Shareholders exert control over managers with:
- Meetings (AGM)
• Performance related pay to provide incentives

• The agents control the business and are usually comprised of a board of directors and senior managers

• Managers and directors run the business on behalf of the owners, making the day to -day decisions.

• The principle-agent problem arises because information failure. between managers and owners, means that managers may not be viewed by shareholders as maximising profits

• If the objectives of managers are different to shareholders, manages may not even be trying to achieve the same objecrives

Question 10

utility maximisation: managers may enjoy:

Answer 10

• The status of running a large team
  • Having a large office
  • Having a prestigious company car

not bearing the success of the business

Question 11

what is an example of profit satisficing

Answer 11

o Lazy managers may want to have an easier time at work, and accept lower profits that are still acceptable to shareholders

Question 12

Social welfare explain

Answer 12

• The firm, in part or in whole, exists to benefit wider society
• To increase social welfare the firm may donate a large % of profits

Question 13

explain what a Corporate social responsibility (CSR) does

Answer 13

CSR may involve the business doing, or sponsoring, chority work or encouraging employees to volunteer

(little compared to social welfare)

Question 14

analysis

how can owners minimise the principle agent problem?

Answer 14

Owners can minimise the principal-agent problem by aligning the incentives of managers with owners with performance related pay. This way the managers are incentivised to maximise the profits of the firm because the size of their remuneration is directly linked to the financial performance of the firm.

Question 15

analysis

how will firms choose objectives?

Answer 15

A firm will choose an objective, or group of objectives, that reflect the objectives of the owners. Firms that are owned by shareholders will usually want to maximise profits, whereas firms owned by the government will usually want to increase social welfare.
Some firms, such as those owned by charitable trusts, may have more leeway to aim for a range of different objectives.

Question 16

judgement: what will the objectives of the firm depend on?

Answer 16

The objective or objectives that a firm chooses will depend on the owners, and the extent to which the principal-agent problem exists. The larger the principal-agent problem, the greater the degree to which the objectives of the owners and managers may diverge.

Question 17

Judgement

non-maximising objective of social welfare

Answer 17

extent to which the non-maximising objective of social welfare benefits the firm over profit maximisation depends upon the preferences of the target market. Assuming the target market is large enough, the more strongly the target market feel about the causes supported by the social welfare objective, the greater the potential benefit of increased sales.

Question 18

evakuation : 4 points, advantages

Answer 18

• utility maximisation
• social welfare
• CSR
• Profit satisficing

Question 19

Advantages: utility maximisation

Answer 19

the ‘trappings of power’ may be necessary to recruit the most productive and effective employees

Question 20

advantages: social welfare

Answer 20

• in private firms, social welfare may be popular with customers increasing sales
• most public sector firms have social welfare as their objective

Question 21

advantages: CSR

Answer 21

CSR may lead to happier and so more productive employees
- cheaper to achieve than social welfare

Question 22

advantages: profit satisficing

Answer 22

May prevent unscrupulous, though legal, behaviour that can lead to new legislation being imposed

Question 23

disadvantages: utility maximisation

Answer 23

The ‘Trappings of power” may be expensive and unnecessary

Question 24

4 disadvantages

Answer 24

• utility maximisation
• social responsibility
• CSR
• Profit satisficing

Question 25

disadvantages: social responsibility

Answer 25

High Opportunity cost of not earning more profit

Question 26

disadvantage: CSR

Answer 26

The opportunity cost of CSR is diverted attention and effort away from more expensive

Question 27

disadvantage: profit satisficing

Answer 27

leads to lower profits than are possible