Utility Maximization

Herbert Simon, a noble prize winner had proposed an alternate theory of firm behavior. According to this theory (Simon 1956), firms do not aim at maximizing anything (profits, sales, etc), due to imperfections in data and incompatibility of interest of various constituent of an organization. Instead, they set up for themselves some minimum standards of achievement which they hope will assure the firm’s viability over a long period of time. This would require satisfying all the constituents of the firm, including the stock holders, management, employees, customers, suppliers and government.

The satisfying objective, in fact is a multiple goal and it is very difficult to practice and achieve. This is because human beings by nature want satisfaction not only in an absolute sense but in a relative sense as well. In other words, stockholders may be satisfied say with a dividend rate of 20% if the top management’s salary, including perquisites is no more than rupees ‘x’ a year, but if the latter stand at rupees ‘2x’ a year, even a dividend rate of 40% may be unsatisfactory. Similarly employees may be content with a bonus of 8% if the dividend rate is 10% and the profit rate on capital employed is around 10%.

The non-profit objectives include goals such as, maximization of quantity and quality of output subject to a break even budget constraint, administrators’ utility maximization, maximization of factor productivity, and maximization of cash flows.

The rationale, for the objectives are inherent in the nature of the public sector firms and not-for-profit organization. These units are engaged in the production of essential goods (such as gas, electricity, transport and electricity) and public goods (such as national parks, museums, national defense and flood control) and render services to a group of clients (such as patients of a hospital) and to their members / contributors (such as the members of a trade union, of a cooperative firm or of a country club).

The funds for such organizations come from general government funds, donation and members’ contribution. Since there is no unambiguous objectives function for these managers to maximize, they look for a level of services that satisfies those paying for it or those who deserve them most in the public eye, and thereby protect the job of the management.