The objectives of business firms

In the simplest orthodox model of business firms the objective is simply profit, or market value, and the more the better. But many scholars have qualified or questioned this simple specification. There have been efforts to shore up the standard formulation by detailing the linkage between owner interests and management actions. Ob­ j ectives other than profit value have been proposed by some authors, while others have questioned whether firms have consistent objec­ tives at all, in the sense of choice criteria representable by a scalar­ valued function. The criticisms range from the highly heretical (such as Cyert and March on organizational goals) to the obviously ortho­ dox (such as the recent literature on “stockholder unanimity”). Be­ cause of the scope and thoroughness of existing discussions in the literature, it is both impossible and unnecessary to review all the issues here; we attempt only to identify the major themes. There are, however, some aspects of orthodoxy’s treatment of the motivational sources of firm behavior that relate importantly to our concerns with the modeling of capabilities and that have received only limited attention in the literature. To these we will devote more attention.

The amount of effort that has been devoted to the problem of the obj ectives of the business firm can be regarded as indicative of the severity of the intellectual strain produced by two opposed consider­ ations. On one side is the institutional fact of the large business organization- the sheer number of individuals involved, the diver­ sity of their roles and the complexity of their relationships, the rela­ tive permanence of the organization and its concerns compared to the typical terms for which individuals serve as employees, stock­ holders, or even as chief executive officers . On the other side is the individualist utilitarian philosophy underlying neoclassical eco­ nomic theory, together with such specific manifestations thereof as the optimality theorems of modern welfare economics. In this philo­ sophical framework, economic organization in its entirety is ap­ praised for its effectiveness in satisfying the wants of individuals. A fortiori, the business firm is viewed as in some sense an instrumental­ ity of individuals, rather than as an autonomous entity. If the busi­ ness firm in question is Miller’s Mile there is no real problem in accommodating this need of the normative framework by assuming that the operations of the mill directly reflect the interests of Miller. If it is General Mills, a similar linkage between the actions of the fi rm and the interests of its owners remains “natural” for orthodox nor­ mative theory, but is of doubtful credibility for descriptive purposes. The strain becomes severe.

A variety of developments in contemporary orthodoxy are respon­ sive, in one way or another, to the need to replace the “Miller’s Mill” approach with something more plausible . All seem to involve heavy reliance on the categories and conclusions of market analYSis to shore up the theory of the firm. In the general equilibrium theory and port­ folio theory branches of the discussion, maximization of the market value of the firm is unambiguously the objective of the firm . The reason is that in the austere environment of complete and perfectly competitive markets, there is no alternative desideratum left against which the value of the firm might be traded off.

In another line of argument, with a slightly more plausible institu­-tional facade, the “market” for the control of the firm is the one whose effective functioning keeps the firm in line. It is to the external discipline provided by the takeover raider, rather than the internal discipline imposed by Miller, that society looks for the effective func­ tioning of the mill . I There have also been some tentative moves toward a view that is distinctive at once for its intellectual boldness and for its faithfulness to the individualist tradition -the view that the fi rm is a market, a particular pattern of voluntary exchange rela­ tions, and not a unitary actor at all . Whereas before it seemed that the mill was essentially one of the economic roles of Miller, now it is seen to be essentially an organized market in the nexus wheat, flour, grinding services, labor time, and so forth. In this perspective, rela­ tions between superior and subordinate within an organization ap­ pear indistinguishable from market-mediated relationships: “Telling an employee to type this letter rather than to file that document is like my telling a grocer to sell me this brand of tuna rather than that brand of bread” (A1chian and Demsetz, 1972, p. 777).

More radical suggestions for resolving the basic tensions in the theory of the firm have been put forward by a number of authors. These alternative approaches are distinguished, and marked as un­ orthodox, by a greater concern for “descriptive realism” in the treat­ ment of the objectives of the large business fi rm and by a corre­ sponding willingness to sacrifice contact with the normative branch of contemporary orthodoxy. One major camp, briefly discussed in Chapter 2, is that of the managerialists- those who argue that ortho­ dox theory errs primarily by identifying the firm’s interests with those of a constituency that is frequently quite passive (stockholders) rather than those of an obviously and necessarily active constituency (managers), Although managerialists have not fully agreed on an answer to the follow-on question-What, then, are the interests of the manager?- there is substantial consensus that some measure of the size or growth of the firm provides at least a partial opera tional answer to this question, and corresponds to one major area of pos­ sible divergence between the interests of stockholders and manag­ ers.2 It has not escaped notice, however, that the pursuit of firm size as a long-run obj ective entails concern for profitability in the short run. Because of this linkage, and because managerialist analysis is typically conducted with analytical tools made familiar by orthodoxy, managerialism is in some ways a rather mild heresy. Perhaps it will be reassimilated to the main faith in some future ecumenical move­ ment. It may come to be regarded as a refinement of rather than an alternative to the orthodox theory-a refinement that may become well established in certain rather narrow application areas, such as models of managerial consumption-on-the-job and certain problems of corporate finance.

Another heterodox approach, less sharply delineated than the managerialist school, denies that firm behavior can be interpreted as pursuit of the interest of a single dominant constituency. Rather, it sees behavior as the consequence of a bargaining process structured by shifting patterns of coalition formation. This view was put for­ ward, in particular, by Cyert and March ( 1963). For them the “goals” or “objectives” of the firm cannot be characterized by an objective function of a grand optimization that imposes a coherent structure on all the firm’s actions. In their view, the question of the firm’s ob­ j ective, in that sense, can never be resolved because it would involve too much tilDe-consuming bargaining over too many hypothetical choices. Rather, the firm persists in a state of “quasi-resolution of conflict, ” and the firm’s goals may be conceived as akin to the terms of a treaty among the participants, according to which they will jointly seek to deal with their common environment. As in the case of treaties among nations, a shift in that environment may render the treaty obsolete, in which case a period of renewed negotiation or overt conflict may ensue.

Even if shared interests and effective bargaining among top man­ agers suffice to produce agreement on high-level objectives, di­ vergent interests regarding implementation may still be a major factor in the concrete behavior of the firm. Objectives like profit, market share, or growth do not serve to guide action in the absence of specific understanding as to how they are to be achieved. Unless this understanding is obvious, shared by all those who are involved in decision making, even the deepest commitments to a common ul­ timate objective will not serve to focus attention and coordinate ac­ tion. To serve this purpose, objectives must be articulated in such a way that they are relevant to the decisions at hand. The person responsible for deciding whether or not to repair a machine is af­ forded little help by his acquiescence in a general profit goal for the firm; he must have an objective defined in terms of the predictable consequences of his own actions. Put another way, objectives to guide action must be proximate, and specialized to the decisions in question. This suggests, on the one hand, that choice of operational objectives is an important arena of managerial decision. On the other hand, it prompts recognition of the abundant opportunities for con­ flict that inhere in the task of dividing operational responsibilities among middle managers, and in the elaboration of systems of control and incentive that are required to align the actions of low-level employees with high-level objectives.

In fact, the discussion in Cyert and March about quasi-resolution of conflict and the literature on divergence of interests between stockholders and managers represent only a small segment of a seriously neglected problem: the shaping role of intraorganizational conflict. Williamson, in his analysis of “opportunism” in the em­ ployment relation, has traced the outlines of a more substantial piece (1975, ch. 4) . Doeringer and Piore (1971) have called the attention of economists to the role of internal labor markets in partially recon­ ciling worker and manager interests. Economists have yet to concern themselves with such things as managerial career systems and their possible implications for the time horizons affecting managerial choice, or for the willingness to cut losses when an undertaking or policy commitment is threatening to fail .

These considerations lead us to concur fully with Cyert and March on one major point: possession of a complete, clearly defined objec­ tive function is not a necessary condition for business operation in the real world; all that is required is a procedure for determining the action to be taken. While criteria for choosing form an important part of many such procedures, the criteria need not be derived from some global obj ective function. And it seems to us, as it did to them, that this proposition has an important corollary: the imputation of such an objective function to the firm is not a sine qua non of effective theory construction. Presumably, if the firms in the world can get along without being entirely clear about their goals, so can the firms in a theoretical model. The concern that orthodoxy has lavished on the question of objectives is a reflection of the logical imperatives of i ts own normative structure- and also, as we have suggested, of its aspiration to reach broad normative conclusions on the efficacy of market mechanisms. To discard that normative baggage is to greatly expand the available options for dealing with motivational issues in the theory of the firm.

Most of these options seem to fall under one or the other of two broad theoretical strategies. The first would restore, at the level of the individual organization member or subunit, the assumption of defi­ nite objectives that has been discarded at the level of the firm as a whole. It would then seek to understand the behavior of the firm as a whole in terms of the divergent interests of various constituencies and the specific procedures by which those interests interact to pro­ duce the actions of the firm as such. Some orthodox theorists, willing to grant the implausibility of treating large firms as unitary actors, might well concur with behavioralists on the general appropri­ ateness of this reductionist strategy. They would differ sharply, of course, in the modeling of the procedures by which divergent inter­ ests interact: orthodoxy would favor some noncooperative game framework, while behavioralism would draw more heavily on in­ sights from organization theory and studies of “bureaucratic poli­ tics. II 4 In empirical application, both approaches suffer und er limita­ tions of access to data on the nature of constituent interests and on the structure of the internal political process-and also, when such access is possible, on the complexity of the phenomena and their rel­ ative remoteness from the crude and aggregative measures of overt firm behavior with which the economist typically wants to deal.

The second strategy is the one we adopt in our own modeling ef­ forts, and in some ways lies closer to textbook orthodoxy. It seeks to capture with a few simple assumptions the most consistently operating and powerful motivational forces tending to shape the behavior of the firm as a whole. Recognizing that the real causal sources of firm actions do involve divergent interests and complex internal political processes, it nonetheless emphasizes the utility of a simple and tractable approximation that relates directly to the ques­ tions of interest, compared with a more elaborate and realistic treat­ ment that risks inconclusiveness on those questions. However-and at this point we diverge from orthodoxy-this approach to business motivation does not warrant a great effort to assure that behavior is represented as being “perfectly prompt and rational.” On the con­ trary, in view of the nature of the deliberate approximation to the complex underlying reality, it is more natural to represent large- scale motivational forces as a kind of persistent pressure on decisions, a pressure to which the response is sluggish, halting, and sometimes inconsistent. And it may be noted that this is the same view of domi­ nant motivational forces to which one is led if one regards them not as the result of an intellectual quest for perfect consistency, but as the outcome of an imprecise and unsubtle evolutionary purging of mo­ tives that diverge excessively from survival requirements . For problems that demand a more refined and exact treatment of busi­ ness objectives, the appropriate tack is not to polish up the rational­ ity with which the model firm pursues its imputed simple objective of profit or growth, but rather to recall that firms as such do not actu­ ally have obj ectives-that is, to revert to strategy one.

Most economists would, we suspect, readily concede the inade­ quacy of the conceptualization of the firm as a rational actor when the task is to explain particular decisions by particular large fi rms. The concession only underscores the question of why, in general theory construction, the objective function approach is so deeply en­ trenched. There are many other ways to represent motivational influ­ ences in a theoretical model; our own models illustrate only a few of the possibilities. In particular-as our own models illustrate- the plausible assumption that making money (in some sense) is a domi­ nant business motivation need not be represented as profit or present value or market value maximization. The choice of those spe­ cific representations is easily understood as a response to demands for definiteness, precision, and internal consistency. But the source of those demands is not to be found in the realities of business behavior. They are demands that economic theorists impose upon themselves, perhaps in the mistaken belief that the achievement of definiteness, precision, and internal consistency in the theory re­ quires the imputation of the same traits to the subject matter.

Source: Nelson Richard R., Winter Sidney G. (1985), An Evolutionary Theory of Economic Change, Belknap Press: An Imprint of Harvard University Press.

Leave a Reply

Your email address will not be published. Required fields are marked *