Site Loader
Rock Street, San Francisco

The Neo-Classical Theory of the Firm

Maximisation of profits is when marginal revenue in a firm
is equal to marginal costs. The neo-classical theory of the firm is a concept
that suggests that the only goal of a firm is to maximise profits and that all
other goals are secondary and likely to be achieved through profit
maximisation. This theory assumes that the manager of the business is also its
owner and that factors of production must always be rewarded. One could argue
that in theory, most if not all firm objectives can be traced back to a core
goal of profit maximisation. For example, if a company’s goal is to increase
production then that, in theory, should lead to profit maximisation the costs
per unit will decrease.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!

order now

The Agency Problem

The issue with believing that profit maximisation is the
only goal of the firm is that often there is now a separation between ownership
and management. This has been shown to result in a conflict of interests
between the principals and the agents of the firm. Agents doesn’t always
consider profit maximisation as a priority, which leads to the principals
having to put pressure on them to act in that direction. The agency problem is
often controlled in two ways; remuneration policy and corporate governance. Remuneration
policies vary between companies, but usually include the offering of stock
options and monetary bonuses to the agents. This helps the owners guide their
agents towards desiring profit maximisation as it would lead to higher rewards
for themselves. Another form of countering the principal-agent problem is
corporate governance. Corporate governance is the system used to regulate and lead
firms. In the UK, corporate governance is a legal requirement for listed
companies since June 2010. Through a strictly structured form, the objectives
and goals of the managers will be reconciled with those of the owners, often
leading to an increased interest in profit maximisation. This, however, is becoming
criticised as while the will of the shareholders has a stronger value through corporate
governance, other stakeholders’ interests are less weighted when comparing the two
together (Nwafor, 2014). Not everyone agrees that profit maximisation should be
the only goal of the firm, which is becoming clearer as the modern firm evolves.

 Alternative Motives

There are multiple theories surrounding the possible
alternative motives of managers. Two branches of such theories are the
managerialism branch and the behaviourism branch. Managerialism has been
defined as a combination of the knowledge of management and their philosophy to
control business decisions, while withdrawing any decision-making power from
other stakeholders for the frim (Klikauer,2013). Three theorists of the
managerialism concepts are William Baumol, Robin Marris and Oliver E.

 Baumol’s theory of sales revenue maximisation
argues that due to the structure of modern firms, where ownership and
management are separated, agents of the firm are more likely to pursue sales
maximisation as it is a more advantageous goal from their perspective. First,
financial institutions are more willing to finance companies with large
increasing sales. Another argument would be that increasing sales lead to
higher salaries and other earnings, primarily for the managers but also
secondarily for the employees (Baumol, 1976NK1 ).

Marris’ theory of growth maximisation
suggests that managers are motivated to maximise their own utility, which is reliant
on the growth of the firm. The shareholders desires for profit maximisation, Marris
argues, also must be taken into consideration as the manager’s job security is dependant
on the satisfaction of the shareholders. Thus, the firm has two aim, maximising
growth, and profit maximisation which in this theory are reached through differentiated
diversification, the growth of the company through the creation of new products
(Marris, 1968).

Post Author: admin


I'm Dora!

Would you like to get a custom essay? How about receiving a customized one?

Check it out