Cost Savings, Wages and the Growth of the Firm

Abstract

The conventional theory regards the firm as a production unit in which optimal price and input combinations are chosen. Decisions are taken on the basis of demand and cost; and the expansion of a firm is constrained primarily by the exogenous variables. Penrose (I959) brought a new dimension into the neoclassical theory of the firm. She argued that the general rules governing the growth of the firm involve managerial limitations since management must operate as a team not as individuals. Since then, considerable research has been done in this area, notably by Baumol (1 962), Marris (i 964), Gould (i 968), and Slater (i 980). While this research has focused mainly on the costs of adjustment arising from expansion, Penrose (I959) and Marris (I97I) gave limited attention to some of the benefits of expansion.' No attention, however, has been given to the cost-saving aspect of growth as it relates to managerial wages, an omission that appears to result from a tendency to ignore both the career decisions managers face and the existence of firmspecific skills required on the job. For example, the models of Baumol and Slater assume constant managerial compensation. This assumption implies that a nongrowing firm can obtain managerial services at a given price without paying adjustment costs (e.g. training costs and losses of coordination), if vacancies need to be filled due to managers' retirement. Such an assumption does not capture the firm-specific nature of management. Promotions and the increased salaries that result from promotion are determined internally, often independent of the bids of manager's services in the market.2 A firm's wage structure may depend on such factors as the promotion opportunities it makes available, its employment policies, etc. Compensation in the managerial market is far more complex than assumed by Baumol and Slater. Thus, instead of treating managerial salary structures as given, we shall view them as endogenous variables. In the process of growth, costs of adjustment and cost savings are two sides of the same coin. Both are equally important. This paper, however, focuses on the cost savings or gains the employer may derive from growth. Firm growth, other