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    Econmics Williamson Model

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    Abhishek Rajpoot
    Williamson's model of managerial discretion posits that managers seek to maximize their own utility rather than profits for owners. Managers' utility depends on factors like salary, job security, power, and status. While managers have discretion, their actions are constrained by owners' minimum profit requirements. The model shows managers balancing staff expenditures, which increase utility, against discretionary profits, reaching equilibrium where marginal utility from each is equal while meeting minimum profit constraints. This results in higher staffing, output, and lower prices and profits than under a pure profit maximization model.

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    Econmics Williamson Model

    Uploaded by

    Abhishek Rajpoot
    57 views6 pages
    Williamson's model of managerial discretion posits that managers seek to maximize their own utility rather than profits for owners. Managers' utility depends on factors like salary, job security, power, and status. While managers have discretion, their actions are constrained by owners' minimum profit requirements. The model shows managers balancing staff expenditures, which increase utility, against discretionary profits, reaching equilibrium where marginal utility from each is equal while meeting minimum profit constraints. This results in higher staffing, output, and lower prices and profits than under a pure profit maximization model.

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    Williamson's model of managerial discretion posits that managers seek to maximize their own utility rather than profits for owners. Managers' utility depends on factors like salary, job security, power, and status. While managers have discretion, their actions are constrained by owners' minimum profit requirements. The model shows managers balancing staff expenditures, which increase utility, against discretionary profits, reaching equilibrium where marginal utility from each is equal while meeting minimum profit constraints. This results in higher staffing, output, and lower prices and profits than under a pure profit maximization model.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    57 views6 pages

    Econmics Williamson Model

    Uploaded by

    Abhishek Rajpoot
    Williamson's model of managerial discretion posits that managers seek to maximize their own utility rather than profits for owners. Managers' utility depends on factors like salary, job security, power, and status. While managers have discretion, their actions are constrained by owners' minimum profit requirements. The model shows managers balancing staff expenditures, which increase utility, against discretionary profits, reaching equilibrium where marginal utility from each is equal while meeting minimum profit constraints. This results in higher staffing, output, and lower prices and profits than under a pure profit maximization model.

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    M.

    Com(semester-II) Applied Economics


    Prof. Rachna Mujoo

    Williamson’s Model of Managerial Discretion


    O.E. Williamson presented his model in the article, ‘Managerial Discretion and Business
    Behaviour’ kmpublished in American Economic Review (1963). According to him managers
    have the discretion of following policies which further their utility maximization objective,
    rather than that of owners. But discretion of managers is limited by the desire of owners to earn
    a minimum level of profits. This acts as a constraint on the profit maximizing behaviour of the
    managers.

    Managers utility function comprises the variables as salary, job security, power ,status, position
    etc. The profits that satisfy the owners have been conceptualized as follows:

    (a) Actual profit Π:


    Actual profit is sales revenue less total costs including staff expenditure

    π=R–C–S
    (b) Reported Profit ΠR:
    This actual profit is reported to the tax authority after deducting managerial emoluments. In
    other words it is the difference between actual profit and management slack (nonessential
    managerial expenditure)

    ΠR = π – M = R = C – S – M
    (c) Minimum Profit Π0:
    This is indeed the minimum amount of profit (after tax) needed to pay satisfactory dividends to
    the shareholders, without which the ‘job security’ of the manager may be at stake. This is
    because if shareholders do not get reasonable dividends then either there will be a possibility of
    takeover or the top management may be dismissed.

    ΠR ≥ π0 +T

    Thus reported profits should be sufficient enough cover minimum profit plus the taxation.
    (d) Discretionary profit ΠD:
    This is also a residue, i.e., the amount of profit left after subtracting the minimum profits and the
    tax
    πD = π – π0 – T

    (e) Discretionary investment, ID:


    This is a residue of the amount left from the reported profit after setting aside minimum profit
    and meeting the tax obligations. Thus

    ID = π R – π0 – T
    The difference between discretionary profits and investment arises due to M(management slack
    ) which is incorporated in the former but not in the latter. Thus

    πD = ID+ M

    if M=0; then πD =ID as πR = π

    The model
    According to Williamson, managers are concerned with the goodwill of the firm only to the ex-
    tent that it favours their own personal motives and ambitions. He argues that the most important
    motive of managers are desires for salary, security, dominance and professional excellence

    These can be gained by incurring additional expenditure on staff, managerial emoluments and
    discretionary investment. Williamson argues that managers have discretion in pursuing policies
    which maximize their own utility rather than seeking the maximization of profits which maxi-
    mize the utility of most shareholders (i.e., the owners of the company). The function can be
    written as

    Um = ƒ(S, M, ID)
    where Um = managerial utility, S = monetary expenditure on staff including managerial salary,
    M = Managerial slack, absorbed as a cost, and ID = amount of discretionary investment. Apart
    from salary directly, managerial power and status in the firm also depend on number of staff
    working under him. This being directly related to salary is clubbed with it in the Um function.
    Management slack concerns non essential expenditure on lavishly furnished offices, luxurious
    company car and the like. Discretionary investment is the amount of funds the managers can use
    according to their will. Maximization of the above utility function is subject tominimum profit
    constaint.
    Price in the model is P= f ( X, S, e)
    That is , P is a function of output, staff expenditure and a demand shift parameter showing
    autonomous change in demand. Cost is assumed to be an increasing function of output.
    Confining only to a simplified model where M is taken as nil, the mathematical and
    diagrammatic illustration has been given in the succeeding paragraphs. Thus
    Um= f (S, ID)
    Where M=0, and therefore as πR = π
    ID = π – π0 – T
    Or,
    Maximise: Um= f [S,( π – π0– T) ]
    Subject to: πR ≥ π0 + T

    Diagrammatically equilibrium of the firm in Williamson’s model can be shown by


    first drawing indifference map for managers based on their utility function. These
    ICs show the indifference of managers between staff expenditure and discretionary
    profit ( πD = ID ). These curves have the usual properties.

    Source:A. Koutsoyiannis, Macmillan


    The relationship between discretionary profit and staff expenditure is determined
    by the profit function.

    Source:A. Koutsoyiannis, Macmillan

    With the increase in staff expenditure there is an increase in output and


    discretionary profits up to the point of maximum profits, beyond which
    discretionary profits tend to decline. Increase in staff expenditure beyond c results
    in discretionary profits turning negative.

    Source:A. Koutsoyiannis, Macmillan


    To find the equilibrium, manager’s indifference map and discretionary profit curve
    is brought together. The point of tangency of profit-staff curve with the highest
    possible managerial indifference curve at point e shows the equilibrium of the firm.
    Since ICs have a negative slope, the equilibrium point will be at the falling part of
    profit curve. Thus according to Williamson, there is a greater preference for staff
    expenditure by the managers. The staff expenditure here will be greater than that of
    a profit maximiser. This model implies higher output, lower price and lower level
    of profit than the profit maximization model.

    References
    1. A. Koutsoyiannis, Macmillan
    2. H.L. Ahuja,Advanced Economic Theory

    _______________________________

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