This essay will be discussingthe benefits and downsides of profit maximisation, the principal agent problem,other objectives a firm should think about and also answer the question, isprofit maximisation the only objective of a firm.According to Duflo &Karlan 2012, economic theories have claimed that firms will do anything tomaximize their profit. In 2013, Nekipeloy stated that the “maximisation ofeconomic profit is a driving motive of firm’s activity according to theneoclassical theory”, this results to profit maximisation becoming one of themain firm objectives. Many firms see profit maximization, which is described byBlack, Hashimzade and Myles (2017) as an act of making as much profit aspossible for a business, as a way of growing their firm.
Various firms believe, maximising profits would “lead to an economicallyefficient or welfare maximising outcome” (Hussain, 2012), and would give theman “incentive and a reward” (Northrop, 2013). This increase in profit, could increasethe wealth of managers and shareholders of the business, and be used to improvethe quality of products, through research and development.Although firms want tomaximise profit, owner and managers may not always have the same ambitions,this is known as the principal-agent problem which, according to The Economist(2012), is defined as the tendency of managers to run companies to suit theirown interests rather than the interests of their owners. Due to this, profitmaximisation may no longer be the main objective of a firm, discussed by Black,Hashimzade and Myles, 2017. Though owners may want to maximise profit, managersmay want to focus more on improving the motivation of the employees. In 2008,Delmar and Wiklund published that a manager’s growth motivation has a uniqueinfluence on a firm’s outcome, which is beneficial for the business in theshort and long term.
However, the principal agent problem has many downsidesfor a business, it can show a lack of communication between the managers andthe owners. This could reflect negatively on a business and eventually resultin a poorly managed business, and their reputation diminishing. However, thisproblem can be solved with the help of the corporate governance which “sets astandard of good practice in relation to board leadership” (Financial reportingcouncil, 2016), this benefits a firm because the government can ensure and helpmanagers and owners run their business with every stakeholders interest in mind.According to Saha (2014) firmobjectives need not be limited to profit maximisation only, firms should focuson other objectives as well. A monopolistic firm, which Doyle (2016) describesas “a non-competitive market situation in which there is only on seller” notonly wants to make profit in both short and long run, but also want to increasetheir market share so that they can gain monopoly power and act as price makersto influence the price of the products in their particular market. A downsideof increasing market share is that firms may have pressure to produce efficientproducts.
There is also some managerialobjectives such as “utility maximization” (Fort, 2015), which result inmanagers increasing their prestige. However, managers shouldn’t always assumethat maximising their satisfaction will also maximise the chances of the firms’survival, reported by Cohen in 2013, because although the managers aresatisfied, doesn’t mean that employees and owners will also be, and unsatisfiedemployees would reduce productivity.Behavioural economics “is theaccumulation of a substantial amount of empirical evidence which contradictsthe assumptions on conventional economic theory” (McDonald, 2008), and conventionaleconomics is about maximising utility. Behavioural economics is defined as “thestudy of psychology into the analysis of decision making” (Partington, 2017).In 2007 Pitelis’s article bases on Cyert and March’s theory about behaviouraleconomics stated that “behavioural theory is one of the two majoreconomics-based theories of the firm”.
This benefits the firm because decisionswill be made do benefit all the stakeholders that are involved. Firms have manyresponsibilities also, such as performing in an ethical way and having acorporate social responsibility, which is said to be “a crucial element to thesurvival and development of a business” (Martí-Borbolla & Ortiz-Arango, 2016). In 2014 the ACCAPR stated that behavingethically and having a corporate social responsibility can benefit firms inmany ways, one of them being that it makes employees want to stay with thebusiness, resulting to a reduction in labour turnover and therefore an increasein productivity overtime. Another advantage from the ACCAPR 2014 is that when afirm is ethical, it can attract investors and keep its share prices high,thereby protecting the business from any takeovers, resulting in them beingable to grow a strong business.Firms shouldn’t always be seton maximising their products, as there are many disadvantages. One of thembeing that maximising profit may not always help with a business’ growth, itall depends on the elasticity of demand, “the ratio between proportional changein quantity demanded and proportional change in price” (Black, Hashimzade and Myles2009). If a firms products have a price elastic demand, then an increase in theprice, could result in a reduction in the number of new and loyal customers thata firm will have, and reduce a firm’s total revenue. This is because customerswill start going to different businesses that sells the same product at acheaper price.
Figure 1 The Importance of Price Elasticity of Demand (Doyle, 2016) Figure 1 shows that if prices increase from P2 to P0, thenthe Quantity demanded would decrease from Q2 to Q0, which suggests that even asmall change in the price of an elastic product, would dramatically decreasethe level of demand. This concept links to another responsibility of a firm, asfirm’s responsibility to meet the needs of their stakeholders. Stakeholders aredefined as “a person who has a legitimate or vested interest in the activitiesof an organisation” (Heery & Noon 2017), in this case, the customers arethe firms’ stakeholders. The firm needs to make sure that their products arewhat the customers want, and at a price that they are willing to pay.
Overall,profit maximisation isn’t always the only objective of the firm, thoughmaximising profits can be rewarding to firms, because it increases wealth, itcan also be damaging, as it prevent them from meeting the needs of theirstakeholders. There are also many other objectives and responsibilities thatfirms have to think about, such as maximising utility, performing in an ethicalway and increasing their market share, however each of these have their owndownsides but are still important.