In addition, it is the essential first step in the process of building up a theory of markets, and from that, a theory of the process of resource allocation in the economy as a whole, and these have given considerable insight into the workings of free market economies. Nevertheless, there has been a great deal of dissatisfaction with the traditional theory of the firm. Partly, this arises from a desire for realism for its own sake. Partly, it stems from the fact that certain predictions of the theory seem to have been refuted, e.g. that firms will not change price in response to a change in a fixed cost.
Finally, the importance of oligopolistic markets has created a need for revision of the theory of the firm, for two reasons: (a) the indeterminacy of the standard theory of the firm in situations of oligopoly suggests that if definite predictions are to be made, more attention must be paid to the actual behaviour of firms in such situations; and (b) the fact that oligopolistic firms are to some extent shielded from competitive pressures means that they have discretion to pursue goals other than profits.
Since the early 1950s, there has been a steady development of theories which attempt to improve upon the traditional theory. The most significant developments have concentrated on the objectives of the firm, i.e. the assumption of profit maximization. It was observed that shareholders, the recipients of profits and the owners of the firm, tend not to participate actively in running their firms, but instead just expect a reasonable level of dividend to be maintained, while managers actually control the decision-making of the firm. This then led to a series of theories based on the hypothesis that decisions would be taken to further the objectives of the top executives, subject always to the constraint that shareholders were paid satisfactory levels of dividends.
Thus, a theory put forward by W. J. Baumol in Business Behaviour, Value, and Growth suggested that firms would try to maximize their size, as measured by sales revenue, since managerial satisfaction and rewards depended more on size than profits. This led to certain predictions of behaviour which differ from those which would be made by profit maximization, e.g. firms would produce larger outputs and advertise more than under profit maximization, and would respond to an increase in fixed costs by raising prices.
A model on similar lines was developed by Oliver B. Williamson in The Economics of Discretionary Behaviour. He suggested that the satisfaction of managers depended on the sizes of their departments (as measured by administrative expenditure), the amount of declared profits they could retain rather than distribute to shareholders (since this then gave them discretion to make investments which do not have to meet with the approval of shareholders), and finally the size of expense accounts and amount of other perquisites (company cars, etc.) which managers are able to get for themselves.
Again, the theory gives a wide range of predictions which differ both from the classical model and the theory of Baumol just described. A third model somewhat in this vein is that developed by R. Marris in The Economic Theory of Managerial Capitalism, which took the maximization of the rate of growth of the firm as being the managerial objective. The notable feature of this model is that it drops the static framework of the conventional theory (maintained in the two models discussed above) and attempts explicitly to construct a dynamic analysis of the firm.
The common feature of these 'modern' theories of the firm is that they concentrate on the objectives of the firm, tending still to ignore problems of organization, and imperfections in information. They also assume that the firm attempts to maximize something, i.e. seek the greatest value possible, rather than achieve certain satisfactory levels of sales, profits, etc. In these respects, they are still very close to the traditional approach. The most significant departure from this has been made by the behavioural theory of the firm, which drops the assumption that firms maximize something, and instead concentrates on the decision processes of the firm, and the way in which these are affected by the organizational environment. This last theory probably comes closer than any other to being a realistic description of real-world firms.
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