Objectives of the Firm Essay

The received scotch assumption underlying the analysis of crockeds is derive maximation. Real world familys, however, faculty non, and m all times do non, fool decisions based on the r individually-maximization objective, or at least exclusively on the hit-maximization objective. Other objectives include (1) sales maximization, (2) pursuit of individualized eudaimonia, and (3) pursuit of companionable welf be. Although self-coloureds argon assumed to make decisions that increase meshing in standard economic analysis, real world devoteds often fall out different(a) objectives on a periodic basis.Some smasheds set their sights on increase sales. For other firms the owners or employees be inclined to enhance in-person living standards. And much than a few firms take steps that promote the overall eudaimonia of society. In some cases, these other objectives help a firm pursue take in maximization. In other cases, they prevent a firm from maximizing profit. shekels Maximization Profit maximization is the process of obtaining the highest possible take of profit through the payoff and sale of goods and services.This is the guiding principle underlying the analysis of short-run production by a firm. In theatrical roleicular, economic analysis is assumed that firms undertake stageions and make the decisions that increase profit. Profit is the discrepancy between the total revenue a firm receives from deceiveing fruit and the total cost of producing that output. Profit-maximization representation that a firm seeks the production train that generates the greatest difference between total revenue and total cost. work out how profit maximization competency work for The goofy Willy confederation.Suppose that The pathetic Willy lodge generates $100,000 of profit by producing 100,000 Stuffed Amigos, the difference between $1,000,000 of revenue and $900,000 of cost. * If profit falls from this $100,000 take aim when The nutlike Willy Company arrests to a greater extent (100,001) or few (99,999) Stuffed Amigos, then it is maximizing profit at 100,000. Alternatively, if profit squeeze out be increased by producing to a greater extent or less, then The Wacky Willy Company is non maximizing profit at the current take aim of production. Suppose, for example, that producing 100,001 Stuffed Amigos adds an supererogatory $11 to revenue but merely $9 to cost.In this case, profit can be increased by $2, r distributivelying $100,002, by producing iodin more Stuffed Amigo. As such(prenominal) 100,000 is NOT the profit maximizing take of production. * In contrast, suppose that producing 99,999 Stuffed Amigos reduces cost by $11 but solo reduces revenue by only $9. In this case, profit can wishingwise be increased by $2, reaching $100,002, by producing one less Stuffed Amigo. As such 100,000 is NOT the profit maximizing level of production. sales Maximization A middling, and often pursued objective of fi rms is to maximize sales, that is, to sell as much output as possible. Clearly sales conduce to revenue, meaning that maximizing sales is also bound to maximize revenue. b atomic number 18ly as the analysis of short-run production indicates, maximizing sales does NOT necessarily maximize profit. So why do firms do it? are firms unreasonable? Are they irrational? Do they NOT understand the elementary economic principles of short-run production? For some firms, the answers to these headers could be yes.But for other firms, sales maximization is actually a reasonable, even better, alternative to profit maximization. Consider, the day-to-day production of Wacky Willy Stuffed Amigos. Suppose the President of The Wacky Willy Company, William J. Wackowski, issues a corporate directive to sell as many Stuffed Amigos as possible, to maximize sales. Is Willy Wackowski wacky? It ability be that Mr. Wackowski has no knowledge of basic economic principles. Alternatively Wacky William power have more business genius than it appears.In occurrence, if the price received from selling Stuffed Amigos is greater than the cost of producing each one, and looks to lodge that way regardless of the quantity explicated, then a reasonable determination is to maximize sales. If sales are greater, then so in any case is profit. Wacky Willy does NOT maximize profit under these circumstances. That is, it does not produce the quantity that achieves the highest possible profit. However, with each Stuffed Amigo produced, profit increases. In fact, Wacky Willy might not KNOW the profit-maximizing production level.All it knows is that selling more Stuffed Amigos, increases profit. While sales maximization can serve as a means of pursing profit maximization, it can also prevent a firm from maximizing profit. The reason, of course, is that if sales become so enlarged that the cost of production increases such that marginal cost exceeds marginal revenue, the maximizing sales does not m aximize profit. Pursuit of Personal social offbeat The passel who make decisions for a business are, in fact, concourse. They have likes and dislikes. They have ad hominem lasts and aspirations just like people who do not make decisions for firms.On occasion these people ingestion the firm to pursue their own personal welfare. When they do, their actions could enhance the firms profit maximization or, in many cases, prevent profit maximization. How about a few examples? Once again, consider William J. Wackowski, the president of The Wacky Willy Company. Perhaps Willy enjoys the finer things in lifea large ho single- cling tod function, envision cars, and expensive vacationswhich require a hefty income. As the primary theatrical roleowner of The Wacky Willy Company, when the business maximizes profit, then William J. Wackowski benefits with more income.In this case, the pursuit of personal welfare coincides with profit maximization. Alternatively, suppose that the Mr. Wacko wski hates the color color. He simply baulk to produce ANY purple Stuffed Amigos. However, foodstuff studies clearly indicate that clouders want purple Stuffed Amigos. Moreover, the purple fabric that would be usanced to produce purple Stuffed Amigos is significantly less expensive than other colors. Mr. Willy clearly is wacky in this case. His purple-phobia prevents profit maximization. William the Wackster might also decide to enhance his corporate life style at the expense of corporate profit.He could, for example, give himself a bigger, more luxurious (but unneeded) office, a higher (but unneeded) salary, a friendship jet (also unneeded), lenify tickets to Shady Valley Primadonnas baseball team (clearly unneeded) and other (unneeded) amenities that are NOT needed to profitably produce Stuffed Amigos. These improve Williams personal welfare, but at the expense of corporate profit. Pursuit of Social Welfare The people who make decisions for firms also have social conscienc es. Part of their likes and dislikes might be related to the overall state of society.As such, they might use the firm to pursue social welfare, which could enhance or prevent the firms profit maximization. How might William J. Wackowskis pursuit of social welfare enhance or prevent profit maximization of The Wacky Willy Company? Suppose that William wants a depriveer environment. As such, he might apply more costly environmentally friendly production techniques and materials. He does his part to clean the environment, but at the expense of order profit. Then again, Mr. Wackowski might feel that government environmental musical note regulations restrict capital enthronisation and economic growth.As such, William might have The Wacky Willy Company use part of its advertising budget to promote this view stage. He might even use company revenue to set up the Wackowski invention for Policy Studies that is two a scientific think tank and a special interest lobbying organization w ith the goal of reducing environmental quality regulations. While the pursuit of social welfare is likely to reduce company profit, it could have the opposite effect as well. Such activities could give The Wacky Willy Company a likeable in the public eye(predicate) image that motivates people to buy more Stuffed Amigos than they would otherwise.In fact, some firms use the pursuit of social welfare as one aspect of their overall advertising efforts. They enhance their public image at the same time they do something good for society. intrinsic Selection Whichever objective a firm pursues on a day-to-day basis, the notion of inherent selection suggests that successful firms intentionally or circumstantially maximize profit. That is, the firms best suited to the economic environment, and thus generate the most profit, are the ones that tend to hold water.The natural selection of business firms is an adaptation of the biological process of natural selection, in which biological enti ties best suited to the natural environment are the ones that start. The concept of economic natural selection means that those firms that generate the greatest profit are the ones that avoid bankruptcy and survive to produce another(prenominal) day. While firms might pursue sales maximization, personal welfare, or social welfare, only those firms that also maximize profit remain in business. 2) The following is from chapter one in the text Financial guidance and Policy, by James C.Van Horne, Copyright 1974 by Prentice-Hall. It is classic finance. THE fair game OF THE FIRM In this course, we assume that the objective of the firm is to maximize its valuate to its packetholders. Value is represented by the market price of the companys common phone line, which, in turn, is a reflection of the firms enthronement, financing, and dividend decisions. Profit Maximization vs. Wealth Maximization Frequently, maximization of profits is regarded as the prim objective of the firm, but it is not as inclusive a goal as that of maximizing stockholder riches.For one thing, total profits are not as important as earnings per share. A firm could al shipway raise total profits by issuing melodic line and using the proceeds to invest in Treasury bills. Even maximization of earnings per share, however, is not a fully appropriate objective, partly because it does not specify the timing or duration of expected emergences. Is the enthronement shed that pull up stakes produce $100,000 return 5 years from now more valuable than the project that will produce annual returns of $15,000 in each of the next 5 years?An answer to this interrogative sentence depends upon the time pry of money to the firm and to investors at the margin. Few existing stockholders would think favourably of a project that promised its first return in 100 years. We essential take into account the time pattern of returns in our analysis. Another shortcoming of the objective of maximizing earnings per share is that it does not consider the try or un trustedty of the prospective earnings electric current. Some investment projects are far more high- encounter than others. As a result, the prospective sprout of earnings per share would be more uncertain if these projects were undertaken.In addition, a company will be more or less risky depending upon the amount of debt in relation to equity in its capital structure. This risk is known as financial risk and it, too, contributes to the uncertainty of the prospective stream of earnings per share. Two companies whitethorn have the same expected future(a) earnings per share, but if the earnings stream of one is subject to considerably more uncertainty than the earnings stream of the other, the market price per share of its stock may be less. For the reasons above, an objective of maximizing earnings per share may not be the same as maximizing market price per share.The market price of a firms stock represents the focal judgment of all market participants as to what the measure out is of the particular firm. It takes into account present and prospective future earnings per share, the timing, duration, and risk of these earnings, and any other factors that bear upon the market price of stock. The market price serves as a performance index or report card of the firms progress it indicates how well management is doing in behalf of its stockholders. Management vs. Stockholders In certain situations the objectives of management may differ from those of the firms stockholders.In a large corporation whose stock is widely held, stockholders exert very little inhibit or influence over the operations of the company. When the control of a company is separate from its ownership, management may not always act in the best interests of the stockholders Agency Theory. Managers sometimes are said to be satisficers rather than maximizers they may be content to play it safe and seek an acceptable level of growth, being more concerned with perpetuating their own existence than with maximizing the value of the firm to its shareowners.The most important goal to a management teamof this break up may be its own survival. As a result, it may be unwilling to take reasonable risks for fear of making a mistake, thereby becoming conspicuous to the outside suppliers of capital. In turn, these suppliers may pose a threat to managements survival. It is true that in order to survive over the long run, management may have to behave in a manner that is reasonably consistent with maximizing stockholder wealth. Nevertheless, the goals of the deuce parties do not necessarily have to be the same. Maximization of shareholder wealth, then, is an appropriate guide for how a firm should act.When management does not act in a manner consistent with this objective, we must recognize this as a constraint and determine the opportunity cost. This cost is measurable only if we determine what the outcome would have been had the f irm attempted to maximize shareholder wealth. A Normative Goal Because the principal of maximization of shareholder wealth provides a rational guide for running a business and for the in effect(p) apportionment of resources in society, we use it as our assumed objective in considering how financial decisions should be made.The purpose of capital markets is to efficiently allocate nest egg in an economy from ultimate savers to ultimate users of funds who invest in real assets. If savings are to be channeled to the most promise investment opportunities, a rational economic criteria must exist that governs their flow. By and large, the allocation of savings in an economy occurs on the basis of expected return and risk. The market value of a firms stock embodies both of these factors. It therefore reflects the markets trade-off between risk and return.If decisions are made in keeping with the likely effect upon the market value of its stock, a firm will attract capital only when its investment opportunities justify the use of that capital in the overall economy. Put another way, the equilibration process by which savings are allocated in an economy occurs on the basis of expected return and risk. Holding risk constant, those economic units (business firms, households, financial institutions, or governments) willing to pay the highest yield are the ones entitled to the use of funds.If rationality prevails, the economic units bidding the highest yields will be the ones with the most promising investment opportunities. As a result, savings will tend to be allocated to the most efficient users. Maximization of shareholder wealth then embodies the risk-return tradeoff of the market and is the focal point by which funds should be allocated in spite of appearance and among business firms. Any other objective is likely to result in the suboptimal allocation of funds and therefore lead to less than optimal level of economic want satisfaction. This is not to say tha t management should ignore the question of social responsibility.As related to business firms, social responsibility concerns such things as protecting the consumer, paying fair wages to employees, maintaining fair hiring practices, financial backing education, and becoming actively involved in environmental issues like clean air and water. Many people feel that a firm has no choice but to act in socially responsible ways they argue that shareholder wealth and, perhaps, the corporations vary existence depends upon its being socially responsible. However, the criteria for social responsibility are not clearly defined, making reflection of a consistent objective function difficult.Moreover, social responsibility creates certain problems for the firm. One is that it falls unevenly on different corporations. Another is that it sometimes conflicts with the objective of wealth maximization. Certain social actions, from a long-range point of view, unmistakably are in the best interests o f stockholders, and there is little question that they should be undertaken. Other actions are less clear, and to engage in them may result in a decline of profits and in shareholder wealth in the long run. From the standpoint of society, this decline may produce a conflict.What is gained in having a socially desirable goal achieved may be offset in whole or part by an accompanying less efficient allocation of resources in society. The latter will result in a less than optimal growth of the economy and a lower total level of economic want satisfaction. In an era of unfilled wants and scarcity, the allocation process is extremely important. Many people feel that management should not be called upon to resolve the conflict pose above. Rather, society, with its broad general perspective, should make the decisions necessary in this area.Only society, playing through Congress and other representative governmental bodies, can enunciate the relative tradeoff between the achievement of a social goal and the sacrifice in the efficiency of apportioning resources that may accompany fruition of the goal. With these decisions made, corporations can engage in wealth maximization and thereby efficiently allocate resources, subject, of course, to certain governmental constraints. Under such a system, corporations can be viewed as producing both private and social goods, and the maximization of shareholder wealth remains a viable corporate objective.