Some critics question why the value maximization criterion is used as a foundation for studying firm behavior. Do managers try to optimize (seek the best result) or merely satisfice (seek satisfactory rather than optimal results)? Do managers seek the sharpest needle in a haystack (optimize), or do they stop after finding one sharp enough for sewing (satisfice)? How can one tell whether company support of the United Way, for example, leads to long-run value maximization? Are generous salaries and stock options necessary to attract and retain managers who can keep the firm ahead of the competition? When a risky venture is turned down, is this inefficient risk avoidance? Or does it reflect an appropriate decision from the standpoint of value maximization?
It is impossible to give definitive answers to questions like these, and this dilemma has led to the development of alternative theories of firm behavior. Some of the more prominent alternatives are models in which size or growth maximization is the assumed primary objective of management, models that argue that managers are most concerned with their own personal utility or welfare maximization, and models that treat the firm as a collection of individuals with widely divergent goals rather than as a single, identifiable unit. These alternative theories, or models, of managerial behavior have added to our understanding of the firm. Still, none can supplant the basic value maximization model as a foundation for analyzing managerial decisions. Examining why provides additional insight into the value of studying managerial economics.
Research shows that vigorous competition in markets for most goods and services typically forces managers to seek value maximization in their operating decisions. Competition in the capital markets forces managers to seek value maximization in their financing decisions as well. Stockholders are, of course, interested in value maximization because it affects their rates of return on common stock investments. Managers who pursue their own interests instead of stockholders’ interests run the risk of losing their job. Buyout pressure from unfriendly firms (“raiders”) has been considerable during recent years. Unfriendly takeovers are especially hostile to inefficient management that is replaced. Further, because recent studies show a strong correlation between firm profits and managerial compensation, managers have strong economic incentives to pursue value maximization through their decisions.
It is also sometimes overlooked that managers must fully consider costs and benefits before they can make reasoned decisions. Would it be wise to seek the best technical solution to a problem if the costs of finding this solution greatly exceed resulting benefits? Of course not. What often appears to be satisficing on the part of management can be interpreted as valuemaximizing behavior once the costs of information gathering and analysis are considered. Similarly, short-run growth maximization strategies are often consistent with long-run value maximization when the production, distribution, or promotional advantages of large firm size are better understood. Finally, the value maximization model also offers insight into a firm’s voluntary “socially responsible” behavior. The criticism that the traditional theory of the firm emphasizes profits and value maximization while ignoring the issue of social responsibility is important and will be discussed later in the chapter. For now, it will prove useful to examine the concept of profits, which is central to the theory of the firm.