This and shareholders of the business, and be

This essay will be discussing
the benefits and downsides of profit maximisation, the principal agent problem,
other objectives a firm should think about and also answer the question, is
profit maximisation the only objective of a firm.

According to Duflo &
Karlan 2012, economic theories have claimed that firms will do anything to
maximize their profit. In 2013, Nekipeloy stated that the “maximisation of
economic profit is a driving motive of firm’s activity according to the
neoclassical theory”, this results to profit maximisation becoming one of the
main firm objectives. Many firms see profit maximization, which is described by
Black, Hashimzade and Myles (2017) as an act of making as much profit as
possible for a business, as a way of growing their firm. Various firms believe, maximising profits would “lead to an economically
efficient or welfare maximising outcome” (Hussain, 2012), and would give them
an “incentive and a reward” (Northrop, 2013). This increase in profit, could increase
the wealth of managers and shareholders of the business, and be used to improve
the quality of products, through research and development.

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Although firms want to
maximise 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 their
own interests rather than the interests of their owners. Due to this, profit
maximisation may no longer be the main objective of a firm, discussed by Black,
Hashimzade and Myles, 2017. Though owners may want to maximise profit, managers
may 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 unique
influence on a firm’s outcome, which is beneficial for the business in the
short and long term. However, the principal agent problem has many downsides
for a business, it can show a lack of communication between the managers and
the owners. This could reflect negatively on a business and eventually result
in a poorly managed business, and their reputation diminishing. However, this
problem can be solved with the help of the corporate governance which “sets a
standard of good practice in relation to board leadership” (Financial reporting
council, 2016), this benefits a firm because the government can ensure and help
managers and owners run their business with every stakeholders interest in mind.

According to Saha (2014) firm
objectives need not be limited to profit maximisation only, firms should focus
on other objectives as well. A monopolistic firm, which Doyle (2016) describes
as “a non-competitive market situation in which there is only on seller” not
only wants to make profit in both short and long run, but also want to increase
their market share so that they can gain monopoly power and act as price makers
to influence the price of the products in their particular market. A downside
of increasing market share is that firms may have pressure to produce efficient
products.

There is also some managerial
objectives such as “utility maximization” (Fort, 2015), which result in
managers increasing their prestige. However, managers shouldn’t always assume
that maximising their satisfaction will also maximise the chances of the firms’
survival, reported by Cohen in 2013, because although the managers are
satisfied, doesn’t mean that employees and owners will also be, and unsatisfied
employees would reduce productivity.

Behavioural economics “is the
accumulation of a substantial amount of empirical evidence which contradicts
the assumptions on conventional economic theory” (McDonald, 2008), and conventional
economics is about maximising utility. Behavioural economics is defined as “the
study of psychology into the analysis of decision making” (Partington, 2017).
In 2007 Pitelis’s article bases on Cyert and March’s theory about behavioural
economics stated that “behavioural theory is one of the two major
economics-based theories of the firm”. This benefits the firm because decisions
will be made do benefit all the stakeholders that are involved.

Firms have many
responsibilities also, such as performing in an ethical way and having a
corporate social responsibility, which is said to be “a crucial element to the
survival and development of a business” (Martí-Borbolla & Ortiz-Arango, 2016). In 2014 the ACCAPR stated that behaving
ethically and having a corporate social responsibility can benefit firms in
many ways, one of them being that it makes employees want to stay with the
business, resulting to a reduction in labour turnover and therefore an increase
in productivity overtime. Another advantage from the ACCAPR 2014 is that when a
firm is ethical, it can attract investors and keep its share prices high,
thereby protecting the business from any takeovers, resulting in them being
able to grow a strong business.

Firms shouldn’t always be set
on maximising their products, as there are many disadvantages. One of them
being that maximising profit may not always help with a business’ growth, it
all depends on the elasticity of demand, “the ratio between proportional change
in quantity demanded and proportional change in price” (Black, Hashimzade and Myles
2009). If a firms products have a price elastic demand, then an increase in the
price, could result in a reduction in the number of new and loyal customers that
a firm will have, and reduce a firm’s total revenue. This is because customers
will start going to different businesses that sells the same product at a
cheaper price.

 

Figure 1 The Importance of Price Elasticity of Demand (Doyle, 2016)

 

 

 

 

Figure 1 shows that if prices increase from P2 to P0, then
the Quantity demanded would decrease from Q2 to Q0, which suggests that even a
small change in the price of an elastic product, would dramatically decrease
the level of demand. This concept links to another responsibility of a firm, as
firm’s responsibility to meet the needs of their stakeholders. Stakeholders are
defined as “a person who has a legitimate or vested interest in the activities
of an organisation” (Heery & Noon 2017), in this case, the customers are
the firms’ stakeholders. The firm needs to make sure that their products are
what 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, though
maximising profits can be rewarding to firms, because it increases wealth, it
can also be damaging, as it prevent them from meeting the needs of their
stakeholders. There are also many other objectives and responsibilities that
firms have to think about, such as maximising utility, performing in an ethical
way and increasing their market share, however each of these have their own
downsides but are still important.