Baumol
3FM Assessed Essay
40 minutes
To what extent does empirical evidence on corporate objectives support the predictions of Baumol’s “Sales Maximisation Hypothesis?”
In Neo-Classical Economic theory of a firm, the owners of a firm are involved in the day to day running of the firm, and therefore their main desire is profit maximisation. In reality firms are most likely run by managers and not by the owners. Because of this there is a lack of goal congruence between the two. Baumol (1959) suggests that manager controlled firms are more likely to have sales revenue maximisation as their main goals rather than profit maximisation favoured by shareholders. He shows that there are several explanations for the managerial emphasis on sales maximisation rather than maximising profits: sources of debt closely monitor sales of firms and are more willing to finance firms with growing or large sales figures; lay- off necessitated by fall in sales leads to industrial unrest and unfavourable investment climate; and with decreased sales (and consequently decreased market power) the firm enjoys lesser powers to adopt effective competitive tactics. As well as managers’ power and prestige and even salaries are more closely correlated with sales as to profits. Judged in this perspective, sales maximisation can be said to be the independent objective in managerial decision making, where ownership and management are clearly separated. This review of evidence will examine the advantages and limitations of Baumols theory on sales-maximisation. The majority of empirical evidence shows that there little correlation between the remuneration of top managers and the profit performance of their companys, instead sale revenue is seen as the major contributor to the salaries of managers. McGuire et al. (1962) tried to test Baumols contention that managers salaries are much more closely related to scale of operations of the firm than with profitability. They devised
40 minutes
To what extent does empirical evidence on corporate objectives support the predictions of Baumol’s “Sales Maximisation Hypothesis?”
In Neo-Classical Economic theory of a firm, the owners of a firm are involved in the day to day running of the firm, and therefore their main desire is profit maximisation. In reality firms are most likely run by managers and not by the owners. Because of this there is a lack of goal congruence between the two. Baumol (1959) suggests that manager controlled firms are more likely to have sales revenue maximisation as their main goals rather than profit maximisation favoured by shareholders. He shows that there are several explanations for the managerial emphasis on sales maximisation rather than maximising profits: sources of debt closely monitor sales of firms and are more willing to finance firms with growing or large sales figures; lay- off necessitated by fall in sales leads to industrial unrest and unfavourable investment climate; and with decreased sales (and consequently decreased market power) the firm enjoys lesser powers to adopt effective competitive tactics. As well as managers’ power and prestige and even salaries are more closely correlated with sales as to profits. Judged in this perspective, sales maximisation can be said to be the independent objective in managerial decision making, where ownership and management are clearly separated. This review of evidence will examine the advantages and limitations of Baumols theory on sales-maximisation. The majority of empirical evidence shows that there little correlation between the remuneration of top managers and the profit performance of their companys, instead sale revenue is seen as the major contributor to the salaries of managers. McGuire et al. (1962) tried to test Baumols contention that managers salaries are much more closely related to scale of operations of the firm than with profitability. They devised