3FM Assessed Essay

40 minutes

To what extent does empirical evidence on corporate objectives support the predictions of Baumol’s “Sales Maximisation Hypothesis?”

In Neo-Classical Economic theory of a firm, the owners of a firm are involved in the day to day running of the firm, and therefore their main desire is profit maximisation. In reality firms are most likely run by managers and not by the owners. Because of this there is a lack of goal congruence between the two. Baumol (1959) suggests that manager controlled firms are more likely to have sales revenue maximisation as their main goals rather than profit maximisation favoured by shareholders. He shows that there are several explanations for the managerial …show more content…

Shipley (1981), in a major study concluded that only 15.9% of 728 UK firms questioned are true profit maximisers. The majority of the firms answered that the aim of their firms is for satisfactory profits. Hornby (1994) conducted a study off 77 Scottish companies and found that only 25% of the respondents are profit maximisers according to the ‘Shipley test’. And again the majority of the firms preferred satisfactory profits to profit maximisation. Although the study tells us little about sales maximisation, Shipley found that it was ranked fourth among principle pricing objectives, and nearly half the firms included sales revenue as at least part of their set of objectives. Larger companies were the ones that cited sales revenue as their principal goal. Since larger companies have a greater separation between ownership and management control, this lends support to Baumols theory. Marby and Siders (1966/7) computed correlation coefficients between sales and profits over 12 years, 1952-63, for 120 large American organisations. Zero or negative correlations between profits and sales would support Baumols hypothesis. The findings showed positive significant correlations between sales revenues and profits. This does not necessarily contradict Baumols hypothesis as sales and profits are positively correlated in Baumols model up to