Motivating the model of Rational Managerial Behavior

Considerations of space permit only a cursory treatment of the question of managerial motivation. The emphasis, therefore, will be on those aspects of motivation that are neglected by the profit maximization hypothesis, but which are essential to the present model. However, this shift of emphasis should not be construed to mean that such goals as self-fulfillment and organizational achievement are unimportant. Rather, since these occupy the center of attention in the usual treatments of motivation, their omission here is merely a device for drawing particular attention to those aspects of managerial behavior that properly should be added to achievement goals in studying the behavior of the business firm. These latter goals, although neglected in the discussion, nevertheless are included in the model. They occur as profits in the “discretionary spending for investment” term.

Modern organization theory treats the firm as a coalition (managers, workers, stockholders, suppliers, customers) whose members have conflicting demands that must be reconciled if the firm is to survive. In the sense that each group in the coalition is essential to the firm’s continuing existence, the members of the coalition can be regarded as “equals.” This view, however, is more useful when observing the firm in a period of crisis than when survival is not a pressing problem. Where survival is not a current concern, restoring a hierarchy among the members based on the attention they give to the firm’s operations may lead to more productive insights. From this viewpoint, management emerges as the chief member of the coalition; its role as the coordinating and initiating agent as well as its preferred access to information permit it quite naturally to assume this primacy position. Thus, although in certain circumstances it may be necessary to give special attention to shifts in demands made by members of the coalition other than managers, under “normal” conditions it may be entirely appropriate to take the demands of the other members (for wages, profits, product, and so forth) as given and leave to the discretion of the management the operation of the firm in some best sense.

Our departure from the conventional view of the firm is in the assumption of what is “best.” Traditionally, this requires that managers choose to operate the firm in a stewardship sense of attending to the stockholders’ best interest by maximizing profits. The behavioral model proposes that managers operate the firm in the only fashion consistent with the assumption of self-interest seeking — in their own best interests. By adapting the notion of “organizational slack” in Chapter 3, specific content is provided to this hypothesis.

In the present model, managers are held to operate the firm so as to maximize a utility function that has as principal components (1) salaries, (2) staff, (3) discretionary spending for investments, and (4) management slack absorbed as cost. This utility function is maximized subject to the condition that reported profits be greater than or equal to minimum profits demanded.

The objective function can be simplified by eliminating the salary component — not because this does not represent an essential element in management’s reward schedule, but because it can be subsumed in the “staff” term. Thus, Simon has shown that executive compensation can be explained by the interaction of the (competitive) salary demands of new employees at the lowest executive levels with a process of social determination within the organization that basically amounts to “staffing.” A perceptive management, therefore, can obtain its salary objectives indirectly (and less ostentatiously) by building pressure from  below through staffing rather than by operating on the salary goal directly. Moreover, managers may find staff attractive for reasons other than the relation it bears to salaries; staff is a source of job security, prestige, and flexibility as well.

That staffs have a tendency, sometimes legitimate and certainly natural, to grow has been widely observed. What may appear originally as a legitimate expansion, however, can, in the absence of binding constraints, easily lead to a  general condition of excessive staff throughout the firm. Indeed, the steady accumulation of excess staff may be difficult to resist as long as the firm is not confronted with adversity. When economic pressures appear, however, the excess will tend to be removed. Thus it will often be after adversity has set in rather than contemporaneously that the evidence of excess staff will appear.

Quantitatively, the expenditures on extra emoluments will ordinarily represent a smaller diversion of resources than will the excess staff activity. Nonetheless, it is clear that managers do indulge in superfluities which themselves appear to be a function of the condition of the environment (the amount spent for  expense accounts, office improvements, and so forth tends to be correlated with economic conditions), and in some circumstances these amounts may not be insignificant. Although it may be claimed that these superfluities are salary substitutes to the management, it is not clear that the amounts of resources involved could in fact be taken as salary without creating counterpressures from the labor and stockholder members of the coalition. Indeed, it seems entirely plausible that a significant amount of these superfluities arise from the political position that a manager enjoys and that they are economic rents which, if removed, would not cause him to seek other employments.

Discretionary spending for investment represents the difference between reported profits and minimum profits demanded. It reflects investment decisions of the firm that are made less on the basis of their economic necessity than on the successful influence of managers in diverting resources to their area. This does not mean that the apparent justification for investment proposals will not remain economic; it merely means that the real basis contains important elements that have ordinarily been neglected.

Investments that are made necessary out of economic considerations are included in the minimum profits demanded constraint for this static model. That the firm’s investments both affect and are affected by the strategies of rivals can be made explicit in a dynamic model. For the present, however, necessitous investments are taken as given. Introducing necessitous investments not as a component of the objective function but rather as a constraint gives preferred status to this class of resource demands. That is, necessitous investments together with dividend demands have a first claim on the firm’s “surplus”; after these have been satisfied, the residual is distributed according to management’s utility function.

To define these notions more precisely requires us to introduce some  profit taxonomy. “Maximum” profits (π * ) are profits that the strictly profit-maximizing firm would obtain by equating marginal revenue to marginal cost. “Actual” profits (π A ) are profits actually earned by the firm that has its objective function augmented to include a “staff” component. That is, the firm that has as its objective function a combination of staff and profit terms will employ staff in the region where the marginal value product is less than the marginal cost of the factor. Hence, actual profits are less than maximum profits — a condition that should be clear when we examine the model in Section 9.3. “Reported” profits (π R ) are the profits the firm admits to and are actual profits reduced by the amount of management slack absorbed as cost. It is out of reported profits that taxes, dividends, and internal growth funds are obtained. “Minimum” (after tax) profits (π 0 ) are profits negotiated by the other members of the coalition that are just sufficient to satisfy  their demands. Reported profits must be greater than or equal to minimum profits as corrected for taxes. If we let MS 1 = management slack absorbed as staff, MS 2 = management slack absorbed as cost, and t = tax rate, we can summarize the above notions as follows:

Discretionary spending for investments is defined as the difference between reported profits and minimum profits and taxes. That is, if I D = discretionary spending for investment:

The above discussion has emphasized a condition of discretion in the  firm’s operations that economic theory has tended to ignore, presumably because these conditions represent a variety of friction that can be safely neglected. For a large class of firms this is probably true. However, it is not a priori evident that all firms belong to this class. Indeed, many firms possess considerable latitude in selecting their strategies for dealing with their environments. This latitude may be due to industry arrangements, local advantages, or simply a buoyant, growing market. Whatever the case, for firms that find themselves sheltered from the rigors of competition, a model drawn more closely along the lines of the one proposed in this chapter than along the lines of the profit maximization hypothesis may be appropriate. On the other hand, since the special advantages that insulate a firm from the pressures of competition are often eroded with time (and may fail to be replaced by others), the behavioral model may best be restricted to predicting short and intermediate run phenomena and other constructions used for the long run.

Source: Skyttner Lars (2006), General Systems Theory: Problems, Perspectives, Practice, Wspc, 2nd Edition.

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