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Manager’s discretion
• Managers, in imperfect markets, want to
maximise their own Utility,
• not profits for owners or shareholders.
• They have the discretion to do so.
• Williamson’s model differs from Baumol’s
in four ways:
Minimum profits for minimum investment and
growth of the firm.
Managers want to maximise their own utility.
2Prabha Panth
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Satisfaction or utility of managers depends on 3
variables,
1) Staff expenditure S. used as a proxy for sales.
Includes management salaries, administrative
expenses, selling expenditure. More the staff exp,
more sales. Power and prestige of managers
increases with S.
2) Management emoluments, M: or management slack
– i.e. luxurious offices, fancy cars, perks,
3) Discretionary investments, Io: amount spent at his
own discretion, e.g. on latest equipment, furniture,
decoration material, etc. to satisfies ego and give
them a sense of pride. These give a boost to the
manager's esteem and status in the organisation.
Managers use that combination of above
variables that maximises their own satisfaction.
Maximise Um = f(S, M, Io)
Where Um = Manager’s Utility
3Prabha Panth
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• Discretion of managers: where owners
and govt expectations are satisfied.
• Minimum Profit Restraint =
Minimum rate of dividend + Minimum
investment + Tax on profits
• Actual Profit > Minimum Profit
Difference between Maximum possible Profit
and Minimum profit constraint = Area of
Discretion.
Larger the gap, more the discretion of
managers.
Can be used by managers to maximise their
own utility.
4Prabha Panth
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• Layers of Profit:
Actual profit RA = R – (C+S), where C = cost
of production, S = Staff expenditure
Reported profit, RR = RA – M, (M = managerial
emoluments)
Minimum profits RM = RR – Tax,
Discretionary profits RD = RA – RR,
i.e. RD = RA – (C + S + M + Tax)
or (M + Io)
These expenditures reduce profits.
RD = is most important for the manager.
Prabha Panth 5
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Objective: to maximise
Manager’s satisfaction.
Given S (staff expenditure
and Io (discretionary Inv),
UM = f( S, Io)
Indifference curves can be
drawn between Io and S.
Fig 1. shows the various
levels of utility (U1, U2, U3)
derived by the manager by
combining different
amounts of discretionary
profits and staff
expenditure.
Higher the indifference
curve, higher the
manager’s utility.
Manager tries to reach
highest indifference curve
possible given the
constraints.
6
U3
U2
U1
S
Io
0
Figure 1
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Relationship between S, Rd and profit
function
• R = f(Q) = f(S) – Rm
• Optimum output
determined by
marginalist rule.
(MC=MR, MC)
• Market conditions are
given,
• Then relationship
between Rd and S is
given in Fig.2
• As sales expenditure ,
Rd first rises up to b (Rd
max), then falls.
• At b, Rd max, S1 not
yet max.
• At c, S max, but Rd = 0
Prabha Panth 7
Rd
Rd max
S max,
but Rd
=0
S1
S
0
Figure 2
a
b
c
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Equilibrium of the firm
•Firm’s equilibrium is
given at the tangency of
profit-staff expenditure
curve, with the highest
possible managerial IC.
•E = manager’s utility
maximising W and S2.
•b = profit maximising
output, S1.
•But Rd* < R max,
• S2 > S1
•Managers equilibrium at
E, where profit curve is
tangent to highest U3..
•But at E, Rd* < Rm, and
S2 > S1.
•Thus managers prefer
more staff expenditure,
rather than maximise
profits.
8
S1
S
0
Figure 3
a
b
cS2
U1
U2
U3
E
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Criticism:
No empirical proof of such managerial
behaviour.
Managers may not have so much freedom,
Trade unions may demand more S,
The model does not discuss how price is
determined.
Interdependence in oligopoly is not discussed.
Prabha Panth 9