The Divorce of Ownership & ControlA2 Economics Unit 3

Aims and Objectives

Aim:• Understand the divorce of ownership and control.Objectives:• Describe the conflict in objectives between

managers and shareholders.• Analyse the relationship between sales

maximisation and profit maximisation.• Evaluate the pursuit of objectives in the long run

and short run.

Starter

• Split into groups – shareholders and managers of ASDA.

• Decide on 4 objectives you wish to be achieved by ASDAas either a mangeror a shareholder.

Conflict Between Objectives

Profit Maximisation & Dividends

Shareholders

Salaries, working conditions, job security, sales and employment

Managers

Divorce of Ownership & Control

Shareholders• Interested in profit

maximisation and dividends.

• Only interested in managers making profits.

Managers• Incentivised by money.• Salaries determined by size

of firm.• May seek market size in

terms of output, employment and sales rather than profitability.

However, managers want to signal to shareholders that they are performing well and so chose not to profit maximise but

to profit satisfice.

Profit Satisficing• The firm is producing satisfactory profits but

not maximum profit.• Managers keep shareholders quite happy

whilst being able to pursue their own objectives.

• Some opportunity costs still exist though!

Profits Ethics

Sales Maximisation Theory

• Managers would rather work for large firms.

• Greater benefits in terms of salary – sales bonuses.

• Managers may increase sales up to the point where MR = 0

Price £s

Quantity

MR D=AR

0

Sales Maximisation Theory

• At this point the firms MC will be positive.

• Firm not maximising profits.

• Firm maximising sales revenue.

• Reward goes to managers in the form of bonuses instead of profit to shareholders.

Price £s

Quantity

MR D=AR

0

Speed Dating

• Using an AR/MR diagram explain to your date using your whiteboards, how the divorce of ownership and control may occur and how managers utility may be greater than shareholders.

EV: Can Firms Profit Maximise?

• Firms need to know their MC as well as EoD.• Firms product ranges are so complex and MC

data is rarely available.• Firms would also need to vary their prices to

find profit max pt – which may lead to loss of custom.

• Also a time lag between processing info and making decisions to profit maximise.

• Almost impossible for a firm to know if its profit maximising!

Satisficing Vs Maximising

• Firms are more likely to profit satisfice.

• Make sufficient profits to keep shareholders happy, and not waste time and resources trying to find the maximising point.

Long Run Profit Maximisation

• Sales are key to growth.• Growth is key to future profits and managerial

security.• Firms unlikely to undertake short term risky

strategies in case it jeopardises long run survival.

• Firms are likely to be risk averse.

EV: Conclusion

• If managers fail to make profits in SR the firm could be subject to a takeover.

• ‘Capital Market Discipline’ takeovers of firms failing to make the profits their assets are capable of.

• Limits the pursuit of other objectives than profit by managers.

• Short run behaviour could be at the detriment of firm in long run.

• Way around this: delist PLC from stock exchange!

Plenary

1) Give two reasons why firms may choose not to pursue profit maximisation.

2) Explain with the aid of a diagram why if managers are maximising sales, profits are not maximised.