Is Marris Managerial Model Better Than Classical Profit or Baumol's Sales Maximisation Model, Prove Yourself!!
Growth Maximisation Theory of Marris: Assumptions, Explanation and Criticisms!
Robin Marris in his book The Economic Theory of ‘Managerial’ Capitalism (1964) has developed a dynamic balanced growth
maximising model of the firm. He concentrates on the proposition that modem big firms are managed by managers and the
shareholders are the owners who decide about the management of the firms.
The managers aim at the maximisation of the growth rate of the firm and the shareholders aim at the maximisation of their
dividends and share prices. To establish a link between such a growth rate and the share prices of the firm, Marris develops a
balanced growth model in which the manager chooses a constant growth rate at which the firm’s sales, profits, assets, etc.
grow.
If he chooses a higher growth rate, he will have to spend more on advertisement and on R & D in order to create more
demand and new products. He will, therefore, retain a higher proportion of total profits for the expansion of the firm.
Consequently, profits to be distributed to shareholders in the form of dividends will be reduced and the share prices will fall.
The threat of take-over of the firm will loom large among the managers.
As the managers are concerned more about their job security and growth of the firm, they will choose that growth rate which
maximises the market value of shares, give satisfactory dividends to shareholders, and avoid the take-over of the firm. On
the other hand, the owners (shareholders) also want balanced growth of the firm because it ensures fair return on their
capital. Thus the goals of the managers may coincide with that of owners of the firm and both try to achieve balanced growth
of the firm.
Assumptions:
The Marris model is based on the following assumptions:
1. It assumes a given price structure.
2. Production costs are given.
3. There is no oligopolistic interdependence.
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4. Factor prices are constant.
5. Finns are assumed to grow through diversification.
6. All major variables such as profits, sales and costs are assumed to increase at the same rate.
Explanation:
Given these assumptions, the objective of the firm is to maximise its balanced growth rate, G. The G itself depends on two
factors: First, the rate of growth of demand for the firm’s product, GD; and second, the rate of growth of capital supply, GS.
Thus G = GD == GS.
Despite the fact that in modem big firms ownership is divorced from management, owners and managers have a common
goal of balanced growth of the firm. According to Marris, there are two different utility functions for the manager and the
owner of the firm. The utility function of the manager consists of his emoluments, status, power, job security, etc. On the
other hand, the utility function of the owner includes profits, capital, output, market share, etc.
Thus the manager of a firm aims at maximising his utility, and his utility depends upon the rate of growth of the firm.
Though promoting the growth of the firm is the main aim of the manager, yet he is also motivated by his job security. The
manager’s job security depends upon the satisfaction of shareholders who are concerned to keep the firm’s share prices and
dividends as high as possible.
Thus the manager aims at maximising the rate of growth of the firm and the shareholders (owners) aim at maximising their
profits in the form of dividends and share prices. Marris analyses the means by which the firm tries to achieve its growth-
maximisation goal.
The firm may grow in size through the creation of new products which create new demands. Marris calls it differentiated
diversification. The introduction of new products depends upon the rate of diversification, advertising expenses, R&D
expenditures, etc.
Marris establishes the relationship between growth and profits on the demand side through diversification into new
products. The links between growth and profits are different at different levels of growth. In this growth-profits relationship,
growth determines profits. When the rate of growth of the firm is low, the relationship is a positive one.
As new products are introduced, the firm expands (grows) and profits increase. With the further increase in the growth rate
due to greater diversification into new products, the growth-profits relationship becomes negative. This is because there is
the managerial constraint which sets a limit on the rate of managerial growth that restricts the growth of the firm.
The firms’ managerial ability to cope with a great number of changes at once is limited. It is not possible to develop a larger
management team for the development and marketing of new products. The higher rate of diversification requires higher
expenditures on advertising and R &D. As a result, beyond a certain growth rate, the higher growth rate leads to a lower rate of profit. This is illustrated in Figure 4 where the GD curve first rises, reaches the highest point M and then starts falling.
The other aspect of the growth-profits relationship is the rate of growth of capital supply. The aim of the shareholders is to
maximise the growth rate of capital stock. The main source of finance for its growth is profits. Thus profits determine growth
on the supply side.
A higher level of profits provides more funds directly for reinvestment. It also allows more funds to be raised on the capital
markets. It, therefore, allows a higher rate of growth to be funded. This gives a direct and positive relationship between
profits and growth. This is shown in Figure 4 as a straight line GS from the origin.
For the equilibrium of the firm, the growth-demand and growth-supply relationship must be satisfied. This is achieved when
the two curves GD and GS intersect at a point where the growth-profits combination gives the optimum solution. Suppose in
the figure the GS 2 curve intersects the GD curve at point M where profits are maximised.
This point does not provide an optimum solution because the managers desire more growth than is consistent with long-run
profit maximisation. The extent to which they can increase the growth rate beyond point M depends upon their desire for job
security. Their job security is threatened if the shareholders feel that the share prices and dividends are falling and there is
the threat of take-over by other firms. This will affect the growth rate of capital supply (GS). Thus it is the financial
constraint which sets a limit to the growth of the firm on the supply side.
According to Marris, it is the retention ratio which determines the growth rate of capital supply. The retention ratio is the
ratio of retained profits to total profits. If the retention ratio is very low, it means that almost all profits have been distributed
to the shareholders. As a result, there are limited funds available with the managers for the growth of the firm and the
growth rate will be very low.
The growth-supply curve will be very steep as shown by GS 1 curve. The firm’s equilibrium will be at point L where the
GS 1 curve intersects the GD curve. This is again not the optimal equilibrium point of the firm because here the growth rate is low and profits are below the maximum level.
Larger retained profits are required by managers to invest larger funds for the growth of the firm. These raise the retention
ratio which, in turn, leads to higher profits and higher growth rates until point M of maximum profits is reached.
This is again not the optimum equilibrium point of the firm because the managers feel that this combination of higher
growth rate and higher profits is approved by the shareholders and there is no threat to their job security. They will,
therefore, be encouraged to raise the retention ratio further, invest more funds, expand and increase the growth rate of the
firm.
As a result, the growth-supply curve will become flatter and take the shape of GS 3 curve as in the figure where it intersects the DS curve at point E. At this point, distributed profits to shareholders fall. But they are adequate to satisfy the shareholders so that there is no fear of fall in the prices of shares and of the threat of take-overs. There is also job security for managers.
Thus point E is the optimal equilibrium point of the firm. If the managers adopt a higher retention ratio than this, the
distributed profits will fall further and the shareholders will not be satisfied which will endanger the job security of
managers. The existing shareholders may decide to replace the managers. If the distribution of low profits to shareholders
brings a fall in the market prices of shares, it may lead to take-over of the firm.
Criticisms:
Marris’s growth-maximisation model has been severely criticised for its over-simplified assumptions by Koutsoyiannis and
Hawkins.
1. Marris assumes a given price structure for the firms. He, therefore, does not explain how prices of products are
determined in the market. This is a serious weakness of his model.
2. Another defect of this model is that it ignores the problem of oligopolistic interdependence of firms in non-collusive
market.
3. This model also does not analyse interdependence created by non-price competition.
4. The model assumes that firms can grow continuously by creating new products. This is unrealistic because no firm can sell
anything to the consumers. After all, consumers have their preferences for certain brands which also change when new
products enter the market.
5. According to Koutsoyiannis, “Marris’s model is applicable basically to those firms which produce consumers’ goods. The
model is not appropriate for analysing the behaviour of manufacturing businesses or traders.”
6. Marris lumps together advertising and R&D expenses in his model. This is a serious shortcoming of the model because the effectiveness of these two variables is not the same in any given period.
7. Marris assumes that firms have their own R&D department on which they spend much for creating new products. But, in reality, most firms do not have such departments. For product diversification, they imitate the inventions of other firms and
in case of patented inventions they pay royalties for using them.
8. The assumption that all major variables such as profits, sales and costs increase at the same rate is highly unrealistic.
9. It is also doubtful that a firm would continue to grow at a constant rate, as assumed by Marris. The firm might grow faster
now and slowly later on.
10. It is difficult to arrive at the growth rate which maximises the market value of the firm’s shares and the rate at which the
take-over is likely to take place.
Despite these criticisms, Marris’s theory is an important contribution to the theory of the firm in explaining how a firm
maximises its growth rate.
