Chapter 9 Flashcards
Traditional profit-maximizing theories of the firm have been criticized for being unrealistic
Firms wish to maximize profits but for some reason are unable to do so.
Firms have aims other than profit maximization.
Difficulties in maximizing profit.
The main difficulty is a lack of information. Firms are unlikely to know their demand curves and hence their MR curves. Even though they will know how much they are selling, this only gives them one point on their demand curve and no point on their MR curve. The biggest problem in estimating the firm’s demand curve is in estimating the actions and reactions of other firms and their effects.
The problem of deciding the time period over which the firm should be seeking to maximize profits.
Public limited company
a company owned by its shareholders. Shareholders’ liability is limited to the value of their shares. Shares may be bought and sold publicly on the stock market.
The shareholders elect directors and these directors employ professional managers. There is therefore a separation between the ownership and control of a firm.
Profit satisficing
where decision makers in a firm aim for a target level of profit rather than the absolute maximum level.
There are two categories of such:
Theories that assume that firms attempt to maximize some other aim, provided that sufficient profits are achieved.
Theories that assume that firms pursue a number of potentially conflicting aims, of which sufficient profit is merely one.
Managers might respond by using heuristics (rules of thumb/mental shortcuts) to simplify things
Copying the strategy of the most profitable business in the market.
Focusing on relative rather than absolute profits.
Making a satisfactory/target level of profit.
Long-run profit maximization
an alternative theory which assumes that managers aim to shift cost and revenue curves so as to maximize profits over some longer time period.
sales revenue maximization The theory developed by O.E. Williamson argues that managers often have the discretion to choose what policies to pursue. He identified a number of factors that affect manager’s utility.
The four main ones were:
Salary
Job security
Dominance
Professional excellence
Of these only salary is directly measurable, the rest has to be measured indirectly. One way of doing this is to examine managers’ expenditure on various items.
sales revenue maximization
an alternative theory which assumes that managers aim to maximize the firm’s short-run total revenue.
Why? Success of managers may be judged according to the level of sales. Sales revenue will be maximized at the top of the TR curve.
Growth maximization
an alternative theory which assumes that mangers seek to maximize the growth in sales revenue over time.
Growth may be achieved either by internal expansion or by merger.
Growth by internal expansion.
Internal growth required an increase in sales, which requires an increase in the firm’s productive capacity. In order to increase sales, the firm is likely to engage in extensive product promotion and to try to launch new products.
In order to increase productive capacity, the firm will require new investment.
Takeover constraint
the effect that the fear of being taken over has on a firm’s willingness to undertake projects that reduce distributed profits.
Growth through vertical integration advantages
Economies of scale
Reduced uncertainty
Barriers to entry
The major problem with vertical integration is that is may reduce the firm’s ability to respond to changing market demands.
Growth by merger
There are three types of merger:
A merger may be the result of the mutual agreement of two firms to come together.
A horizontal merger
A vertical merger
A conglomerate merger
A horizontal merger
This where two firms in the same industry at the same stage in the production process merge.
A vertical merger
This where two firms in the same industry at different stages in the production process merge.
A conglomerate merger
This where two firms in different industries merge.
Motives for merger
Merger for growth
Merger for economies of scale
Merger for monopoly power
Merger for increased market valuation
Merger to reduce uncertainty (behavior of rivals/economic environment)
Merge due to opportunity
Other motives are
Getting bigger to make the firm less likely to be taken over itself.
Merging with another firm to prevent it being taken over by an unwanted predator.
Asset stripping. Firm buys another firm, breaks it up, sells the profitable bits and probably closing down the remainder.
Empire building.
Broadening the geographical base of the company by merging with a firm in a different part of the country or the world.
Reducing levels of taxation.
Growth through strategic alliances
Strategic alliance
where two firms work together, formally or informally, to achieve a mutually desirable goal. There are many types of strategic alliance between businesses, covering a wide range of alternative collaborative arrangements
Joint ventures
Consortia. Consortium
Franchise
Subcontracting
Network
Joint ventures
This where two or more firms set up and jointly own a new independent firm.
Consortia. Consortium
This is where two or more firms work together on a specific and create a separate company to run the project.
Franchise
This is a formal agreement whereby a company uses another company to produce or sell some or all of its product.
Subcontracting
This is where a firm employs another firm to produce part of its output or some if its inputs.
Network
an informal arrangement between businesses to work together towards some common goal.
Principal-agent problem
Where people (principals) as a result of lack of knowledge, cannot ensure that their best interests are served by their agen
Asymmetric information
where one party in an economic relationship has more information than another.
PA Problem
Two elements to tackle the problem
The principals must have some way of monitoring the performance of their agents.
There must be incentives for agents to behave in the principals’ interests.
Stakeholders (in a company)
people who are affected by a company’s activities and/or performance (customers, employees, owners, creditors, people living in the neighborhood, etc.). they may or may not be in a position to take decisions, or influence decision taking, in the firm.
Organizational slack
where managers allow spare capacity to exist, thereby enabling them to respond more easily to changed circumstances.
Keeping targets fairly low and allowing slack to develop allows all targets to be met with minimum conflict.
