Alternative Goals of the Firm

The standard model assumes profit maximization. However, real firms may pursue other goals as well. Understanding alternative goals is important for analyzing corporate behavior.

Critique of Profit Maximization

Separation of Ownership and Control:
In large corporations, shareholders are the owners, while managers are the executives.
Interests may diverge — Principal-agent problem.

Bounded Rationality:
Managers do not know the exact cost or demand curves.
They use rules and heuristics – “good enough” instead of optimum.

Multiplicity of Stakeholders:
Not only shareholders, but also employees, clients, society.
ESG and sustainable development.

Revenue Maximization (Sales Maximization)

Baumol’s Model:
Managers maximize revenue subject to a minimum profit constraint.

Why revenue?

Manager salaries and status correlate with size
Market share — indicator of success
Company growth — career opportunities

Consequences:

Output is higher than under profit maximization
Price is lower
Profit is not maximized, but “sufficient”

Growth Maximization

Marris’s Model:
The firm maximizes the rate of growth constrained by share price.

Growth requires:

Reinvesting profits (less dividends)
Capturing markets, diversification
M&A activity

Conflict: short-term profit vs. long-term growth.
Investments today reduce profits but create future value.

Managerial Theories

Williamson’s Model:
Managers maximize their own utility—a function of:

Staff size
Expense preferences
Discretionary investments

Consequences:

Bloated staff
Expensive offices, corporate jets
“Empire building”

Satisficing

Simon’s Model:
Instead of maximization—achieving a “satisfactory” level.

Why?

Optimum search is too expensive
Information is incomplete
Cognitive limitations

The firm sets:

Target level of profit, sales, market share
If reached — does not seek improvements.
If not reached — seeks changes.

Behavioral Theory of the Firm

Cyert & March: The firm is a coalition of groups with different interests.
Groups: shareholders, managers, employees, suppliers, customers.

Process:

Negotiations, compromises
Goals are formed in the process, not set externally
“Organizational slack” — reserves for satisfying all

Corporate Governance and Alignment of Interests

Mechanisms for aligning the interests of managers and shareholders:

Compensation:
- Stock options, profit-based bonuses
- Link manager wealth to performance
Board of Directors:
- Supervision of management
- Independent directors
Market for Corporate Control:
- Threat of takeover disciplines management
- Inefficient companies become takeover targets
Managerial Labor Market:
- Manager reputation depends on results
- Incentive to show good performance

For the investor

Agency costs:
- Divergence between managers’ and shareholders’ interests
- Empire building, excessive perks, risk aversion
- Need to analyze corporate governance
Incentive structures:
- How is management compensated?
- Options may create risk-taking
- Bonuses from short-term profit — short-termism
Investor activism:
- Activist hedge funds demand changes
- Pressure on capital return, efficiency

Understanding the real goals of the firm helps to predict its behavior better than the simple profit-maximization model.