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Separation of ownership and management combined with the desire for steady performance which ensures satisfactory profits, tend to make the managers risk avoiders. Top Managers in the modern firm are generally reluctant to adopt highly promising but risk-prone projects. But this approach stabilises the economic performance of the firm and leads to development of orderly markets.
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Liquidity Ratio: Current ratio – ratio of liquid assets to total assets. Low liquidity increases the risk of insolvency (risk=+ve) Leverage/Debt or Debt-Equity ratio: ratio of debt to total assets. High debt-equity ratio exposes the firm to bankruptcy.(risk=+ve) Profit retention ratio: High retention of profits, adds to the reserves contributing to the growth of capital.(risk= -ve) Combining all the above into a single parameter will amount to financial constraint of the firm.
Marris’s Theory of The Managerial Enterprise(contd.) “ The Managers have other ideas. Their utility function includes variables such as Salaries, Job security, Power and status.
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Marris’s Theory of The Managerial Enterprise
“In Corporate firms, there is structural division of ownership and management which allows managers to set goals which do not necessarily conform with those of the owners. The shareholders are the owners. Their utility function includes variables such as profits, size of output, size of capital, market share and 10 public image.
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Baumol’s Model : (contd.)
4 A steady performance with satisfactory amount of profits is preferably to irregular spectacular profits in some one or two years. Having shown high profits, if the level is not maintained, it will lead to discontent of shareholders. 5. Large sales strengthens the competitive power of the firm vis-avis competitors, while low or declining sales diminishes this power of bargaining.
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Baumol’s Model : (contd.)
Rationale of the Hypothesis: 1. Management has been separated from ownership in modern times. 2. This has given powers to Managers who pursue their own goals rather than the goal of the owners. 3. Managers ensure a minimum acceptable level of profit to satisfy the shareholders, but would pursue a goal which enhances their own utility.
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Marris’s Theory of The Managerial Enterprise(contd.)
• Owners being interested in the growth of the firm want maximisation of the growth of the supply of capital, which is assumed to maximise the owner’s utility. • Managers wanting to maximise rate of growth of the firm rather than absolute size of the firm, believe that growth of demand for the products is an appropriate indicator of the growth of the firm.
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• There are two constrains in the Marris’s Model: • 1. The Managerial Team Constraint. Since Management is a teamwork, hiring new managers does not expand managerial capaqcity immediately. New managers take time to get integrated in the team. Managerial tream constraint sets limits to both the rate of growth of demand and rate of growth of capital. • 2. The Job Security Constraint. Managers want job security. Job security attained by pursuing a prudent financial policy which requires the three crucial financial ratios to be maintained at optimum levels.
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Baumol’s Model of Sales Revenue Maximisation
W.J.Baumol suggested Sales Revenue maximisation as an alternative goal to profit maximisation. Managers only ensure acceptable level of profit, pursuing a goal which enhances their own utility.
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Basic assumptions in Baumol’s Static Models:
1. A firm’s decision making is limited to a single period. During this period, the firm attempts to maximise total revenue rather than physical volume of sales. 2. Sales revenue maximisation is subject to provision of minimum required profit to ensure a fair dividend to shareholders, thus ensuring stability of his job. 3. Conventional Cost and Revenue functions are assumed – Cost curves are U-shaped, Demand curve is downwa’s Model : (contd.)
Why Managers attempt to maximise sales rather than profits:1. Incomes of top executives are closely related to sales rather than profits. 2. Banks and financial institutions are impressed by the amount of sales and treat this as a good indicator of the performance of the firm. 3. Large and continuing sales enhance prestige of the Managers, who ensure regular distribution of dividends.