Profit Maximization Theory

I will discuss different business objectives, such as profit maximisation, in this assignment. I will take into account alternative aims a business may have depending on a range of factors and responsibilities.Profit maximisation is when a business is making as much profit as it possibly can and it achieves this when marginal revenue is equal to marginal cost. Common economic theory holds that profit maximisation is the guiding principle for a business’s actions. Although profit maximisation is the primary objective of a business, it is assumed that the managers and owners are not separated, so the business is managed by the owners (Griffiths & Wall 2011).

This is more common in Partnerships and Sole Traders, but it’s rare in Limited Companies. Black, 2017. Profit maximization theory supports a company’s ability to maximize shareholder value. “The discounted flow of profit will equal the share price” (Black, 2017). Limited companies often have principal-agent owners who manage the day-to day operations of the company. Some difficulties arise because of this. Because owners cannot observe the day-to-day decisions made by managers, owners don’t know if profits are being maximized. Most companies are profit-seekers rather than profit maximisers. Managers want to make profits for their company, but they have the option of being more focused on long-term or short-term goals.

A company has many options to make sure that there is no principal-agency problem. This can be done by creating an Employee Shareownership Scheme. This allows employees to be part owners of the company’s shares. These schemes are offered by Waitrose and John Lewis. This would prevent principal-agency problems from occurring. The managers of the business also become part owners. The managers will have the same interests and the same goals as the shareholders.

A company can also offer long-term contracts to its top managers. Managers will be more inclined to consider the long-term interest of the company and offer them a contract that lasts between 5-10 years. Because owners want long-term success for their company, both managers and owners will have the same objectives. Corporate governance can be used to stop a company from falling prey to principal-agency issues. This system allows companies to be controlled. The board of directors is an organization that the owners set up to oversee the management. Corporate governance strives to serve the shareholders best interests (CIMA.2017).

Profit maximization is not the goal of every business. Managers may have different goals depending upon their behavior. Williamson’s theory on utility maximisation could be one explanation. He says managers can choose the goals they want to achieve as long that they are able to make an acceptable profit for their owners. Williamson found that salary was the only measurable factor, while three other unmeasurable factors were also important, such as dominance, professional excellence, job security, and leadership (Sloman 2015). Baumol has also proposed the theory of maximising sales revenue. Managers can be considered successful if their sales revenue exceeds a specified amount. Managers may have to achieve certain levels of sales revenue in order to maintain their prestige, power, or salaries. This would make profit maximisation less important than maximising sales revenues for managers (Sloman 2015).

Marris also suggests that growth is an objective for managers. He believes that if they grow their ’empire’, their status will improve. Marris also suggested that growth was an end. However, others argue that growth won’t get a company far. (Griffiths & Wall 2011, 2011). These are examples of managerialistic behavior, whereas a behaviourist approach would state that managers will compromise their goals to please owners and get satisfactory profits.

Profit maximization is not a long-term strategic plan. A business might be better focusing on longer-term goals such as expansion and growth. Profit maximisation may also have negative consequences for the business’s perception. The business may be trying to reduce costs which could lead to being unprofessional. CIMA, 2017, states that ethics refers to the way someone should act when faced with a situation. This could make the business look bad and cause a decrease in demand, which could result in sales being lost. The business may have multiple ‘discrete group’ interested in its activities. So if the goal is to maximize profits, the business must only concentrate on the shareholders (owners) and not other stakeholders. (CIMA 2017, 2017).

I conclude that profit maximisation isn’t the only goal of a business. There are many possible objectives and problems that can arise, like the principal agency problem.