The Neo-Classical Theory of the FirmMaximisation of profits is when marginal revenue in a firmis equal to marginal costs. The neo-classical theory of the firm is a conceptthat suggests that the only goal of a firm is to maximise profits and that allother goals are secondary and likely to be achieved through profitmaximisation. This theory assumes that the manager of the business is also itsowner and that factors of production must always be rewarded. One could arguethat in theory, most if not all firm objectives can be traced back to a coregoal of profit maximisation.
For example, if a company’s goal is to increaseproduction then that, in theory, should lead to profit maximisation the costsper unit will decrease. The Agency ProblemThe issue with believing that profit maximisation is theonly goal of the firm is that often there is now a separation between ownershipand management. This has been shown to result in a conflict of interestsbetween the principals and the agents of the firm. Agents doesn’t alwaysconsider profit maximisation as a priority, which leads to the principalshaving to put pressure on them to act in that direction. The agency problem isoften controlled in two ways; remuneration policy and corporate governance. Remunerationpolicies vary between companies, but usually include the offering of stockoptions and monetary bonuses to the agents. This helps the owners guide theiragents towards desiring profit maximisation as it would lead to higher rewardsfor themselves.
Another form of countering the principal-agent problem iscorporate governance. Corporate governance is the system used to regulate and leadfirms. In the UK, corporate governance is a legal requirement for listedcompanies since June 2010. Through a strictly structured form, the objectivesand goals of the managers will be reconciled with those of the owners, oftenleading to an increased interest in profit maximisation.
This, however, is becomingcriticised as while the will of the shareholders has a stronger value through corporategovernance, other stakeholders’ interests are less weighted when comparing the twotogether (Nwafor, 2014). Not everyone agrees that profit maximisation should bethe only goal of the firm, which is becoming clearer as the modern firm evolves. Alternative MotivesThere are multiple theories surrounding the possiblealternative motives of managers. Two branches of such theories are themanagerialism branch and the behaviourism branch. Managerialism has beendefined as a combination of the knowledge of management and their philosophy tocontrol business decisions, while withdrawing any decision-making power fromother stakeholders for the frim (Klikauer,2013). Three theorists of themanagerialism concepts are William Baumol, Robin Marris and Oliver E.Williamson.
Baumol’s theory of sales revenue maximisationargues that due to the structure of modern firms, where ownership andmanagement are separated, agents of the firm are more likely to pursue salesmaximisation as it is a more advantageous goal from their perspective. First,financial institutions are more willing to finance companies with largeincreasing sales. Another argument would be that increasing sales lead tohigher salaries and other earnings, primarily for the managers but alsosecondarily for the employees (Baumol, 1976NK1 ).Marris’ theory of growth maximisationsuggests that managers are motivated to maximise their own utility, which is relianton the growth of the firm. The shareholders desires for profit maximisation, Marrisargues, also must be taken into consideration as the manager’s job security is dependanton the satisfaction of the shareholders.
Thus, the firm has two aim, maximisinggrowth, and profit maximisation which in this theory are reached through differentiateddiversification, the growth of the company through the creation of new products(Marris, 1968).