1.5.2 The Objectives of Firms

Profit Maximisation

Assumed objective: In traditional theory, firms are assumed to aim for profit maximisation.

Why? This maximises returns for shareholders through dividends and higher share prices.

Rule: Profit is maximised where \( MC = MR \).

Revenue Maximisation

Objective: Maximise total revenue.

Why? Firms may want to increase market share or benefit from economies of scale to lower average costs. Both of these can increase long-term profitability.

Rule: Revenue is maximised where \( MR = 0 \).

Sales Maximisation

Objective: Maximise the quantity of units sold.

Why? Firms may want to increase market share, clear stock, or practise limit pricing to deter new entrants.

Rule: Sales maximisation occurs where \( AC = AR \), so the firm breaks even and earns only normal profit.

Divorce of Ownership and Control

In large firms, especially PLCs, owner's typically do not run the business on a day-to-day basis. Instead, owners employ professional managers to run the business. Owners/shareholders are the principals and managers are the agents who run the business on their behalf.

The principal-agent problem: Managers may pursue their own objectives, such as higher salaries, sales maximisation, or perks, instead of the owners' goal of profit maximisation.

Cause: The separation of ownership and control means that managers may not have the same incentives as owners, leading to potential conflicts of interest. For example, the owner wants to maximise profits, while the manager may want to increase their own salary or job security/salary, which may not align with profit maximisation.

Possible solutions: Solutions must ensure that managers are incentivised to maximise profits for the owners. This can be achieved through performance-related pay, such as bonuses or stock options.

Satisficing

Objective: Aim for a satisfactory level of profit rather than the maximum possible profit.

Why? Managers may prioritise personal benefits, such as higher salaries, job security, or perks, over maximising profits for shareholders due to the principal-agent problem. Therefore, they may choose to satisfice — achieving a level of profit that is acceptable to shareholders while also meeting their own personal objectives. In smaller businesses, owners may also choose to satisfice to balance work-life priorities or other personal goals.

Result: Output and price are likely to lie between the profit maximisation and sales maximisation points.

Other Possible Objectives

Alongside Profit Maximisation, Revenue Maximisation, Sales Maximisation, and Satisficing, firms may also pursue other objectives such as:

• Corporate Social Responsibility (CSR): Firms may aim to act in a socially responsible manner, considering the impact of their actions on society and the environment.
• Survival: In highly competitive markets or during economic downturns, firms may focus on survival rather than profit maximisation, aiming to maintain operations and avoid bankruptcy.
• Employee Welfare: Firms may prioritise the well-being of their employees, offering better working conditions, benefits, and job security, which can lead to increased productivity and loyalty.
• Social Objectives: Some firms may pursue social objectives, such as promoting diversity, supporting local communities, or contributing to charitable causes, which can enhance their reputation and brand image.

Summary of Objectives