Managerial economics focuses on the strategies of managing the firms and understanding business dynamics. This article discusses in detail, seven critical models that explain the complex relationship between the owners and the managers. These models are critical for students to understand the factors and the processes that leads to effective decision making and maintaining a balance of interests of both the stakeholders. Understanding these models is not only essential during the course study but also applicable in business and professional life. We will discuss these models in detail to help you with providing helpful insights which may prove to be beneficial during your coursework or if you are seeking managerial economics homework help with business case studies.
Principal-Agent model is one of the major concepts within the scope of managerial economics, to describe and analyze the interaction between the owners (principals) and the managers (agents). Managers are appointed by the owners to run the business on their behalf which may result in conflict of interest. Sometimes managers may act in their own self-interest over owner’s objectives leading to the conflicts.
Example: Often in a large firm with many owners relying on the CEO to make decisions, the CEO may be focused on growing the company for self-reputation rather than maximizing the shareholders’ value.
Case Study: The Enron scandal is a classic example of the principal-agent problem. Managers benefit themselves by using unethical techniques to create an illusion of sound financial health of the company, but at the expense of shareholders and the overall stability of the firm.
In this model managers work in a way to maximise their own utility in terms of salary, job security, and authority instead of aiming at increasing the firm’s profit. This leads to inefficiency in business operations and mediocre decisions from owners viewpoint.
Example: In publicly held organizations, managers can pursue investments that increase their power or control on certain resources, although these investments may not maximize shareholder value or generate any fruitful returns.
Illustration: A manager may establish an office in the prime location to increase his/her status at the company neglecting better returns by investing on productive assets needed in the company.
According to William Baumol such a model proposes that managers tend to focus on increasing the revenue rather than profits of the firm due to a minimum profit target that has been set by the stakeholder. This approach aims at improving the aspects of managerial utility as a higher revenue results in increasing market power and job security.
Example: Retail companies often focus on increasing the sales volume by offering heavy discounts on products and keeping profits at a bare minimum level. This approach is efficient as it leads to increased sales, though, the overall profit may not increase.
Case Study: Amazon in the early 2000 mainly emphasized on increasing the sales volume rather than profits. The primary objective was to dominate the market and the decision was well supported by its stakeholders who focused on the long-term profits.
According to this model, the managers are likely to prefer firm growth at the expense of profitability because growth provides better pay, employment security, and status. This can bring out an inconsistency between the goals of the manager and the shareholders who seek to maximize their wealth.
Example: Tech startups tend to focus more on increasing customer volume and market share instead of profits to attract investors who are interested in growth prospects of the firm rather than current losses.
Case Study: WeWork pursued its aggressive growth model, which targeted widespread market domination, and excessively focused on its growth while ignoring profitability, which ultimately led to substantial financial problems and reduction in the company’s valuation.
According Robin Marris’s model managers seek to obtain optimum rate of growth of the firm by taking the demand and the capital constraints of the firm. This approach of balanced growth to some extent bring the managerial and the shareholder interests into congruency.
Example: In an organization, profits could be reinvested for research and development for a sustainable growth, striking a balance in between immediate returns and long-term growth.
Illustration: Most times, manufacturing companies, especially, the pharmaceuticals companies, inject a large proportion of their profits towards their research and development of products in the hope of a continuous growth through innovation and penetration into new markets.
Proposed by Richard Cyert and James March, this model considers a firm as a group of stakeholders with different set of interests and objectives. Managers working in such firms are bound to face a conflicting situation due to varying interests and they end up making decisions that barely satisfies the interests of all stakeholders instead of what is optimal for business.
Example: A firm might choose moderate profitability to simultaneously satisfy employee’s demand in terms of payscale, customers and stakeholders.
Case Study: Ford Motor Company in the early 2000s took compromising steps to manage the labor union’s demands of wage increment, customers’ expectation of high quality affordable vehicles and shareholders expectations.
This model extends the scope of stakeholders and includes all the stakeholders such as employees, customers, suppliers, and the community as well. These groups are affected by managerial decisions and the managers must take balanced decisions considering all stakeholders that will be beneficial for the long-term sustainability of the firm.
Example: A firm can adopt environment protection practices which may cost a bit higher but it eventually improves the firm’s image and future stability.
Illustration: A Well-known company in the clothing industry is Patagonia, which focuses on environment friendly practices for achieving the broader objectives of its stakeholders.
Managerial economics involves a combination of concepts and economics and business to prepare students for the business world. Various managerial models are taught during the coursework to highlight different firm control scenarios. Understanding of such models as the principal-agent problem, working on managerial utility maximization and other related models entails both theoretical understanding as well as practical implementation. We offer managerial economics homework help service to bridge the gap between theory and practice. We offer assistance with answering any questions related to these models and solving complex case studies.
It is essential for students studying managerial economics to understand the seven models of firm control. These models provide various business control and decision-making scenarios prevailing in a firm, probable conflicts and unaligned interests between the stakeholders and manager. By learning these models, students can have a deep understanding of how decisions are made in an organisation and the management control factors that influence it. Opt for our managerial economics assignment help service to learn more about these models and other complex topics covered in your course.
How does the principal-agent problem affect firm control?
The principal-agent problem raises an issue of conflict of interests between owners and manager wherein the later may work to achieve goals that are not aligned with the objectives of owner, resulting into inefficient and mediocre decisions.
Why do managers prefer sales revenue maximization over profit maximization?
Managers might prefer sales revenue maximization as this increases the chance of their job security, increases the bargaining power, and boost their renumeration.
What is the significance of the growth maximization model in tech startups?
In tech startups, growth is the major focus as this aids in capturing the market share, attracting investors, and strategically positioning the entity, although in the process this may actually lead to operating at a loss in the short run but with a scope of higher growth prospects.
How does the behavioral model of Cyert and March differ from other models?
The behavioral model acknowledges the firm as an organization of stakeholders who have different goals. So managers must satisfice, settling for a solution that is acceptable to all the concerned stakeholders.
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