A firm’s owners are its shareholders. A large firm may have many shareholders and/or shareholders with limited knowledge of running the firm. So, shareholders appoint directors to run the firm and, in turn, directors appoint managers to run the firm day-to-day. So there is a divorce between ownership and control. Shareholders do not have much day-to-day control. Shareholders only have the power to appoint/sack directors at meetings. Moreover, it may take a lot of shareholders to appoint/sack directors. Directors and managers have the most control over the firm’s day-to-day running.
A firm basically has four objectives to choose from:
1) Profit Maximization.
A firm profit maximizes at . Before Q*, so producing more output will increase total profit. At Q* profits are maximized. After Q*, so producing more output will decrease total profit. Because the firm makes super-normal profit.
Shareholders want to profit maximize because their dividends will be maximized.
2) Revenue Maximization.
A firm maximizes revenue at . maximizes revenue because before that point so additional output adds to total revenue and after that point so additional output decreases total revenue. Super-normal profit is still made, but it is less than under profit maximization.
A firm may want to maximize revenue to raise resources for a big investment. Furthermore, the firm may be trying to increase its market share and monopoly power or drive rivals out of the market. Managers may wish to maximize revenue if their pay is positively linked to revenue. Moreover, managers may revenue maximize for the prestige of maximizing the firm’s assets or stock vale.
3) Sales Maximization.
A firm maximizes sales at . At the firm sells all the output it can without making a loss. The firm breaks-even and earns normal profit only.
A firm may maximize sales to build a brand and create a loyal customer base. Furthermore, the firm may be trying to maximize its market share and monopoly power or drive rivals out of the market. Managers may wish to maximize sales if their pay is positively linked to sales. However, shareholders may sack directors/managers because only normal profit is earned, shareholders want super-normal profit to maximize their dividends.
4) Profit Satisfice.
Managers could profit satisfice, that is, meet a minimum level of profit to appease shareholders and then they seek to meet targets for their own benefit like increasing sales to increase their salaries, increase their time off work or improve their perks and working conditions.