Theories of firm

• Managerial theories:
• Berle & Means – Staff Maximization
• Baumol’s model – Sales Maximization
• Marris’s Theory – Growth Maximization
• Williamson’s theory – Managerial utility
Maximization
• Behavioural theories:
• Simon’s Model - Satisfying Behaviour
• Simple model of Behaviourism
• Value Maximization
 Behavioural Theories
• Behavioural theories combine industrial economics and
organizational theory.
• The firm’s sub-optimal behaviour arises from uncertainty and
conflicting goals of various groups within the firm.
• While managerial theories emphasize the role of mgmt.. The
behavioural theories argue that groups within the firm other
than managers influence the behaviour of the firm.
• The types of behavioural theories proposed are:
• Simon’s Satisfying Behaviour Model
• Cyert & March - Simple model of Behaviourism
 Simon’s ‘Satisficing’ Model

• Simon believed that the relevant information

with the managers was far from complete.
• This model helps in explaining certain real-world
situations.
• Simon’s model is consistent with the theory of
motivation where human action is a function of
drives and it terminates when drives are satisfied.
Flaws in ‘Satisficing’ behaviour

• Knowledge available to the firm for its rational

decision making is imperfect. There are screens
& blockages in flow of information
• It is not easy to determine a “satisfactory level”
• Information about condition is different than
the information about the changes in the
conditions, which is more apt.
Simple Model of Behaviourism

• U = f (S, DI, M)
• Where,
• U = Managerial utility
• S = Expenditure on staff
• DI = Discretionary investment, and
• M = Managerial slack
Simple Model of Behaviourism
The behavioural theory developed by Cyert & March in their
book “A Behavioural Theory of the Firm” can be studied in
the following sequence:
• The firm as a coalition of groups with conflicting goals
• The process of goal formation – the aspiration level
• Goals of the firm
• Means for resolution of conflict
• The Decision Making Process
• Uncertainty & the environment of the firm
Cyert and March based their theory on four actual case studies
and two experimental studies conducted with hypothetical firms.
A simple model for illustration of theory
The model refers to the case of duopoly. The decision process
involves determination of output which is homogeneous, so that
single price will ultimately prevail in the market. No inventories
are allowed in this model. The steps may be outlined as follows:
• Forecast of competitors’ reactions.
• Forecast of firm’s demand.
• Estimation of costs.
• Specification of goals of the firm.
• Evaluation of results by comparing them to the goals.
• Re-examine the estimate of the cost.
• Adapt new solution, else move on.
• Re-exam its estimation of demand.
• Evaluation of new solution
• If goals are not met the firm readjusts downwards its aspiration level.
 Top Management Ways for
smooth functioning
• Budget-share and its use by various groups

• Firm is an adaptive organization; it sets present goals, behaviour & decisions

based on past experience

• Delegation function limits the discretion of various groups of coalition, thus

reducing source of conflict

• Money payments are source of satisfying the various groups conflict

• Side payments means of satisfying some demands
• Slack payments are over & above the demand of efficient groups
• Urgency of some demand puts priority over others, thus gets satisfied earlier
• Decentralization of decision making
 Value Maximization

• Modern theory
• ST profits are sidelined by most firms as
their objective
• Firms often sacrifice their ST profits for
future LT profit
• This theory states objective of the firm is to
maximize the wealth or value of the firm